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Flexible inflation targeting and financial stability: Is it enough to stabilize inflation and output?

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Author Info
Akram, Q. Farooq
Eitrheim, Øyvind

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Abstract

We investigate empirically whether a central bank can promote financial stability by stabilizing inflation and output, and whether additional stabilization of asset prices and credit growth would enhance financial stability in particular. We employ an econometric model of the Norwegian economy to investigate the performance of simple interest rate rules that allow a response to asset prices and credit growth, in addition to inflation and output. We find that output stabilization tends to improve financial stability. Additional stabilization of house prices, equity prices and/or credit growth enhances stability in both inflation and output, but has mixed effects on financial stability. In general, financial stability as measured by e.g., asset price volatility improves, while financial stability measured by indicators that depend directly on interest rates deteriorates, mainly because of higher interest rate volatility owing to a more active monetary policy.

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Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 32 (2008)
Issue (Month): 7 (July)
Pages: 1242-1254
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Handle: RePEc:eee:jbfina:v:32:y:2008:i:7:p:1242-1254

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  1. Adam S. Posen, 2006. "Why Central Banks Should Not Burst Bubbles," International Finance, Blackwell Publishing, vol. 9(1), pages 109-124, 05. [Downloadable!] (restricted)
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  2. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier. [Downloadable!] (restricted)
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  3. Romaniuk, Katarzyna, 2006. "What if the Fed increased the weight of the stock price gap in its reaction function?," Journal of Policy Modeling, Elsevier, vol. 28(7), pages 725-737, October. [Downloadable!] (restricted)
  4. Bean, Charles R, 1983. "Targeting Nominal Income: An Appraisal," Economic Journal, Royal Economic Society, vol. 93(372), pages 806-19, December. [Downloadable!] (restricted)
  5. Allen, William A. & Wood, Geoffrey, 2006. "Defining and achieving financial stability," Journal of Financial Stability, Elsevier, vol. 2(2), pages 152-172, June. [Downloadable!] (restricted)
  6. Alexandros Kontonikas & Christos Ioannidis, 2004. "Should Monetary Policy Respond to Asset Price Misalignments?," Macroeconomics 0404026, EconWPA. [Downloadable!]
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  7. Ball, Laurence, 1999. "Efficient Rules for Monetary Policy," International Finance, Blackwell Publishing, vol. 2(1), pages 63-83, April. [Downloadable!] (restricted)
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  8. Jagjit S. Chadha & Lucio Sarno & Giorgio Valente, 2004. " Monetary Policy Rules, Asset Prices and Exchange Rates," CDMA Working Paper Series 0403, Centre for Dynamic Macroeconomic Analysis. [Downloadable!]
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  9. Bordo, Michael D & Jeanne, Olivier, 2002. "Monetary Policy and Asset Prices: Does 'Benign Neglect' Make Sense?," International Finance, Blackwell Publishing, vol. 5(2), pages 139-64, Summer. [Downloadable!] (restricted)
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  10. Akram, Q. Farooq, 2006. "PPP in the medium run: The case of Norway," Journal of Macroeconomics, Elsevier, vol. 28(4), pages 700-719, December. [Downloadable!] (restricted)
  11. Hoggarth, Glenn & Reis, Ricardo & Saporta, Victoria, 2002. "Costs of banking system instability: Some empirical evidence," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 825-855, May. [Downloadable!] (restricted)
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  12. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-48, April.
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  13. Svensson, Lars E O, 1999. " Inflation Targeting: Some Extensions," Scandinavian Journal of Economics, Blackwell Publishing, vol. 101(3), pages 337-61, September. [Downloadable!] (restricted)
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  14. Nouriel Roubini, 2006. "Why Central Banks Should Burst Bubbles," International Finance, Blackwell Publishing, vol. 9(1), pages 87-107, 05. [Downloadable!] (restricted)
  15. McCallum, Bennett T. & Nelson, Edward, 1999. "Nominal income targeting in an open-economy optimizing model," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 553-578, June. [Downloadable!] (restricted)
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  16. Peel, David & Sarno, Lucio & Taylor, Mark P, 2001. "Nonlinear Mean-Reversion in Real Exchange Rates: Towards a Solution to the Purchasing Power Parity Puzzles," CEPR Discussion Papers 2658, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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Cited by:
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  1. David Pérez-Reyna, . "Una aproximación para analizar la estabilidad financiera por medio de un DSGE," Temas de Estabilidad Financiera 040, Banco de la Republica de Colombia. [Downloadable!]
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