The Diagnostic Financial Accelerator

Lahcen Bounader and Selim Elekdag

No 2024/132, IMF Working Papers from International Monetary Fund

Abstract: We develop a model with diagnostic expectations (DE) and a financial accelerator (FA) that generates mutually reinforcing shock amplification, especially in the case of demand shocks. However, supply shocks can be dampened via a debt deflation channel, which is strengthened amid DE. Importantly, the model results in a worsening of the inflation-output volatility trade-off confronting policymakers. In contrast to most of the literature—which argues against targeting the level of asset prices—our financial accelerator model with DE suggests that targeting house price growth may result in welfare gains.

Keywords: Financial Accelerator; Diagnostic Expectations; Optimal monetary policy; Instrument rules; debt deflation channel; inflation-output volatility trade-off; house price growth; inflation trade-off; model dynamics; Inflation; Asset prices; Housing prices; Consumption; Business cycles; Global (search for similar items in EconPapers)
Pages: 53
Date: 2024-06-28
New Economics Papers: this item is included in nep-ban, nep-cba and nep-fdg
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