Monetary policy and financial stability in the long run
AbstractMost theoretical central bank models use short horizons and focus on a single tradeoff. However, in reality, central banks play complex, long-horizon games and face more than one tradeoff. We account for these issues in a simple infinite-horizon game with a novel tradeoff: higher rates deter financial imbalances, but lower rates reduce the likelihood ofinsolvency. We term these factors discipline and stability effects, respectively. The centralbank's welfare decreases with dependence between real and financial shocks, so it may reduce costs with correlation-indexed securities. In our model, independent central banks cannot in general attain both low inflation and financial stability.
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Bibliographic InfoPaper provided by Norges Bank in its series Working Paper with number 2013/21.
Length: 41 pages
Date of creation: 22 Aug 2013
Date of revision:
Central Bank; Correlation-indexed security; Discipline effect; Stability effect;
Find related papers by JEL classification:
- E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-08-31 (All new papers)
- NEP-BAN-2013-08-31 (Banking)
- NEP-CBA-2013-08-31 (Central Banking)
- NEP-MAC-2013-08-31 (Macroeconomics)
- NEP-MON-2013-08-31 (Monetary Economics)
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