Incorporating Financial Sector Risk Into Monetary Policy Models: Application to Chile
AbstractThis paper builds a model of financial sector vulnerability and integrates it into a macroeconomic framework, typically used for monetary policy analysis. The main question to be answered with the integrated model is whether or not the central bank should include explicitly the financial stability indicator in its monetary policy (interest rate) reaction function. It is found in general, that including distance-to-default (dtd) of the banking system in the central bank reaction function reduces both inflation and output volatility. Moreover, the results are robust to different model calibrations. Indeed, it is more efficient to include dtd in the reaction function with higher coefficient of exchange rate pass through, and with a larger impact of financial vulnerability on the exchange rate, as well as on GDP (or the reverse, there is more effect of GDP on bank’s equity—i.e., what we call endogeneity).
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Bibliographic InfoArticle provided by Central Bank of Chile in its journal Economía Chilena.
Volume (Year): 12 (2009)
Issue (Month): 2 (August)
Other versions of this item:
- Dale F. Gray & Carlos J. García & Leonardo Luna & Jorge E. Restrepo, 2011. "Incorporating Financial Sector Risk Into Monetary Policy Models: Application to Chile," Central Banking, Analysis, and Economic Policies Book Series, Central Bank of Chile, in: Rodrigo Alfaro (ed.), Financial Stability, Monetary Policy, and Central Banking, edition 1, volume 15, chapter 6, pages 159-197 Central Bank of Chile.
- Dale F. Gray & Carlos Garcia & Leonardo Luna & Jorge Restrepo, 2009. "Incorporation financial sector risk into monetary policy models: application to Chile," ILADES-Georgetown University Working Papers, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines inv229, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines.
- Dale Gray & Carlos García & Leonardo Luna & Jorge E. Restrepo, 2009. "Incorporating Financial Sector Risk into Monetary Policy Models: Application to Chile," Working Papers Central Bank of Chile, Central Bank of Chile 553, Central Bank of Chile.
- E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
- E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
- E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
- F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
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