The Financial Accelerator Under Learning and The Role of Monetary Policy
AbstractFinancial frictions have been shown to play an important role amplifying business cycles fluctuations. In this paper we show that the financial accelerator mechanism, analyzed by Bernanke, Gertler and Gilrchrist (1999), combined with adaptive learning can amplify business cycle fluctuations significantly as the balance sheet channel interacts with the presence of endogenous asset price “bubbles”. These large business cycle fluctuations are amplified in a non-linear way by the size of the shocks and by the degree of financial fragility in the economy determined by its leverage. Our preliminary results indicate that even in the presence of endogenous bubbles, responding aggressively to inflation reduces output and inflation volatility. If the central bank adjusts its policy instrument in response to asset price fluctuations, it may reduce output volatility and even inflation volatility in the short run. However, that monetary policy conduct leads to a surge in inflation several periods after the shocks. A policy that aggressively responds to changes in asset prices may marginally reduce output volatility with respect to a policy that reacts aggressively to inflation, but also at the cost of generating inflationary pressures.
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Bibliographic InfoPaper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 590.
Date of creation: Sep 2010
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Other versions of this item:
- Rodrigo Caputo & Juan Pablo Medina & Claudio Soto, 2011. "The Financial Accelerator under Learning and the Role of Monetary Policy," Central Banking, Analysis, and Economic Policies Book Series, in: Luis Felipe Céspedes & Roberto Chang & Diego Saravia (ed.), Monetary Policy under Financial Turbulence, edition 1, volume 16, chapter 7, pages 185-218 Central Bank of Chile.
- NEP-ALL-2011-04-23 (All new papers)
- NEP-CBA-2011-04-23 (Central Banking)
- NEP-DGE-2011-04-23 (Dynamic General Equilibrium)
- NEP-MAC-2011-04-23 (Macroeconomics)
- NEP-MON-2011-04-23 (Monetary Economics)
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- Singh, Aarti & Stone, Sophie, 2012. "Asset Prices, Monetary Policy and Determinacy," Working Papers 2012-06, University of Sydney, School of Economics.
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