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Financial Shocks and Optimal Policy

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  • Dellas, H.
  • Diba, B.
  • Loisel, O.

Abstract

This paper incorporates banks as well as frictions in the market for bank capital into a standard New Keynesian model and considers the positive and normative implications of various financial shocks. It shows that the frictions matter significantly for the effects of the shocks and the properties of optimal monetary and fiscal policy. For instance, for shocks that increase banks' demand for liquidity, optimal monetary policy accepts an output contraction while it would not in the absence of the frictions (or under suitably conducted fiscal policy). We find that optimal monetary policy can be approximated by a simple interest-rate rule targeting inflation; and it also allows large adjustments in the money supply, a property reminiscent of Poole's analysis.

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Bibliographic Info

Paper provided by Banque de France in its series Working papers with number 277.

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Length: 47 pages
Date of creation: 2010
Date of revision:
Handle: RePEc:bfr:banfra:277

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Postal: Banque de France 31 Rue Croix des Petits Champs LABOLOG - 49-1404 75049 PARIS
Web page: http://www.banque-france.fr/
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Keywords: Financial frictions; banking; optimal policy;

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References

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  1. Urban Jermann & Vincenzo Quadrini, 2007. "Financial Innovations and Macroeconomic Volatility," 2007 Meeting Papers 50, Society for Economic Dynamics.
  2. Chari, V V & Christiano, Lawrence J & Kehoe, Patrick J, 1991. "Optimal Fiscal and Monetary Policy: Some Recent Results," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 519-39, August.
  3. William Poole, 1970. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Staff Studies 57, Board of Governors of the Federal Reserve System (U.S.).
  4. Aubhik Khan & Robert G. King & Alexander L. Wolman, 2001. "Optimal monetary policy," Working Papers 01-5, Federal Reserve Bank of Philadelphia.
  5. Andrew T. Levin & Alexei Onatski & John C. Williams & Noah Williams, 2005. "Monetary Policy Under Uncertainty in Micro-Founded Macroeconometric Models," NBER Working Papers 11523, National Bureau of Economic Research, Inc.
  6. Correia, Maria Isabel Horta & Nicolini, Juan Pablo & Teles, Pedro, 2003. "Optimal Fiscal and Monetary Policy: Equivalence Results," CEPR Discussion Papers 3730, C.E.P.R. Discussion Papers.
  7. John B. Taylor & John C. Williams, 2010. "Simple and Robust Rules for Monetary Policy," NBER Working Papers 15908, National Bureau of Economic Research, Inc.
  8. Matthew Canzoneri & Robert Cumby & Behzad Diba & David Lãpez-Salido, 2008. "Monetary Aggregates and Liquidity in a Neo-Wicksellian Framework," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(8), pages 1667-1698, December.
  9. Gertler, Mark & Karadi, Peter, 2011. "A model of unconventional monetary policy," Journal of Monetary Economics, Elsevier, vol. 58(1), pages 17-34, January.
  10. Césaire Meh & Kevin Moran, 2008. "The Role of Bank Capital in the Propagation of Shocks," Working Papers 08-36, Bank of Canada.
  11. Goodfriend, Marvin & McCallum, Bennett T., 2007. "Banking and interest rates in monetary policy analysis: A quantitative exploration," Journal of Monetary Economics, Elsevier, vol. 54(5), pages 1480-1507, July.
  12. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  13. Bernheim, B Douglas, 1991. "Optimal Fiscal and Monetary Policy: Some Recent Results," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 540-42, August.
  14. Mulligan Casey B, 2008. "Is the Treasury Impotent?," The Economists' Voice, De Gruyter, vol. 5(7), pages 1-3, November.
  15. Matthew B. Canzoneri & Robert E. Cumby & Behzad T. Diba, 2004. "The Cost of Nominal Inertia in NNS Models," NBER Working Papers 10889, National Bureau of Economic Research, Inc.
  16. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  17. Robert E. Lucas Jr., 2003. "Macroeconomic Priorities," American Economic Review, American Economic Association, vol. 93(1), pages 1-14, March.
  18. Stefano NERI & Luca SESSA & Federico SIGNORETTI & Andrea GERALI, 2009. "Credit and Banking in a DSGE model," 2009 Meeting Papers 586, Society for Economic Dynamics.
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Citations

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Cited by:
  1. Paolo Angelini & Laurent Clerc & Vasco Cúrdia & Leonardo Gambacorta & Andrea Gerali & Alberto Locarno & Roberto Motto & Werner Roeger & Skander Van den Heuvel & Jan Vlcek, 2011. "Basel III: Long-term impact on economic performance and fluctuations," Questioni di Economia e Finanza (Occasional Papers) 87, Bank of Italy, Economic Research and International Relations Area.
  2. John Keating & Andrew Lee Smith, 2013. "Price Versus Financial Stability: A role for money in Taylor rules?," WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS 201307, University of Kansas, Department of Economics.
  3. Jan Vlcek & Scott Roger, 2012. "Macrofinancial Modeling At Central Banks," IMF Working Papers 12/21, International Monetary Fund.
  4. Meilan Yan & Maximilian J. B. Hall & Paul Turner, 2011. "A Cost-Benefit Analysis of Basel III: Some Evidence from the UK," Discussion Paper Series 2011_05, Department of Economics, Loughborough University, revised Nov 2011.
  5. Matthew Schurin, 2012. "Optimal Fiscal Policy and the Banking Sector," Working papers 2012-40, University of Connecticut, Department of Economics, revised Jul 2013.
  6. Eva Zamrazilová, 2011. "Monetary Policy: Old Lessons and New Challenges," Politická ekonomie, University of Economics, Prague, vol. 2011(1), pages 3-21.

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