Should Monetary Policy Target Financial Stability?

William Chen and Gregory Phelan

No 2021-12, Department of Economics Working Papers from Department of Economics, Williams College

Abstract: Monetary policy can promote financial stability and improve household welfare. We consider a macro model with a financial sector in which banks do not actively issue equity, output and growth depend on the aggregate level of bank equity, and equilibrium is inefficient. Monetary policy rules responding to the financial sector are ex-ante stabilizing because their effects on risk premia decrease the likelihood of crises and boost leverage during downturns. Stability gains from monetary policy increase welfare whenever macroprudential policy is poorly targeted. If macroprudential policy is sufficiently well-targeted to promote financial stability, then monetary policy should not target financial stability.

Keywords: Central bank mandate; Leaning against the wind; Fed Put; Macroprudential policy; Banks; Liquidity (search for similar items in EconPapers)
JEL-codes: E44 E52 E58 G01 G12 G20 G21 (search for similar items in EconPapers)
Pages: 100
Date: 2021-08-04
New Economics Papers: this item is included in nep-ban, nep-cba, nep-fdg, nep-isf, nep-mac and nep-mon
Note: This is a revision of working paper 2020-01
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Citations: View citations in EconPapers (2)

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Related works:
Journal Article: Should Monetary Policy Target Financial Stability (2023)
Working Paper: Should Monetary Policy Target Financial Stability? (2020)
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