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Monetary policy reaction function and the financial cycle

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  • Filardo, Andrew
  • Hubert, Paul
  • Rungcharoenkitkul, Phurichai

Abstract

We examine whether the systematic response of monetary policy to financial imbalances matters for financial stability. We measure how responsive the Federal Reserve's policy is to imbalances in the equity, housing and credit markets. We find that changes in these policy sensitivities predict the subsequent development of financial imbalances. When monetary policy responds more counter-cyclically to market overheating, imbalances tend to decline over time. This effect is distinct from that of current and anticipated interest rate levels – the risk-taking channel. The evidence highlights the importance of the systematic component of monetary policy reaction function in shaping the financial cycle.

Suggested Citation

  • Filardo, Andrew & Hubert, Paul & Rungcharoenkitkul, Phurichai, 2022. "Monetary policy reaction function and the financial cycle," Journal of Banking & Finance, Elsevier, vol. 142(C).
    • Handle: RePEc:eee:jbfina:v:142:y:2022:i:c:s0378426622001303
    DOI: 10.1016/j.jbankfin.2022.106536
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    More about this item

    Keywords

    Monetary policy reaction function; Asset price booms; Credit booms; Monetary policy; Financial cycles; Time-varying models;
    All these keywords.

    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G00 - Financial Economics - - General - - - General
    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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