Central Banking 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 of bankruptcy. We term these factors discipline and stability effects, respectively. The central bank’s welfare decreases with dependence between real and financial shocks, so it may reduce costs with correlation-indexed securities. Generally, independent central banks cannot attain both low inflation and financial stability.
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Bibliographic InfoPaper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 4272.
Date of creation: 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
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