Monetary Policy Rules and Financial Stress: Does Financial Instability Matter for Monetary

Jaromir Baxa, Roman Horvath and Bořek Vašíček ()

Working Papers from Department of Applied Economics at Universitat Autonoma of Barcelona

Abstract: We examine whether and how main central banks responded to episodes of financial stress over the last three decades. We employ a new methodology for monetary policy rules estimation, which allows for time-varying response coefficients as well as corrects for endogeneity. This flexible framework applied to the U.S., U.K., Australia, Canada and Sweden together with a new financial stress dataset developed by the International Monetary Fund allows not only testing whether the central banks responded to financial stress but also detects the periods and type of stress that were the most worrying for monetary authorities and to quantify the intensity of policy response. Our findings suggest that central banks often change policy rates: mainly decreasing it in the face of high financial stress. However, the size of a policy response varies substantially over time as well as across countries, with the 2008-2009 financial crisis being the period of the most severe and generalized response. With regards to the specific components of financial stress, most central banks seemed to respond to stock market stress and bank stress, while exchange rate stress is found to drive the reaction of central banks only in more open economies.

Keywords: financial stress; Taylor rule; monetary policy; time-varying parameter model; endogenous regressors. (search for similar items in EconPapers)
JEL-codes: E43 E52 E58 (search for similar items in EconPapers)
Pages: 46 pages
Date: 2011-01
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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Related works:
Journal Article: Time-varying monetary-policy rules and financial stress: Does financial instability matter for monetary policy? (2013)
Working Paper: Time-Varying Monetary-Policy Rules and Financial Stress: Does Financial Instability Matter for Monetary Policy? (2011)
Working Paper: How Does Monetary Policy Respond to Financial Stress? (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:uab:wprdea:wpdea1101

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