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Time-Varying Monetary-Policy Rules and Financial Stress: Does Financial Instability Matter for Monetary Policy?

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  • Jaromir Baxa
  • Roman Horvath
  • Borek Vasicek

Abstract

We examine whether and how selected central banks responded to episodes of financial stress over the last three decades. We employ a new monetary-policy rule estimation methodology which allows for time-varying response coefficients and corrects for endogeneity. This flexible framework applied to the USA, the UK, Australia, Canada, and Sweden, together with a new financial stress dataset developed by the International Monetary Fund, not only allows testing of whether central banks responded to financial stress, but also detects the periods and types of stress that were the most worrying for monetary authorities and quantifies the intensity of the policy response. Our findings suggest that central banks often change policy rates, mainly decreasing them in the face of high financial stress. However, the size of the policy response varies substantially over time as well as across countries, with the 2008-2009 financial crisis being the period of the most severe and generalized response. With regard to the specific components of financial stress, most central banks seemed to respond to stock-market stress and bank stress, while exchange-rate stress is found to drive the reaction of central banks only in more open economies.

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Paper provided by Czech National Bank, Research Department in its series Working Papers with number 2011/03.

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Date of creation: Jul 2011
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Handle: RePEc:cnb:wpaper:2011/03

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Keywords: Endogenous regressors; financial stress; monetary policy; Taylor rule; time-varying parameter model.;

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Cited by:
  1. Claudiu Albulescu & Daniel Goyeau & Dominique Pépin, 2013. "Financial instability and ECB monetary policy," Post-Print halshs-00943753, HAL.
  2. Borek Vasicek, 2010. "Is Monetary Policy in New Members States Asymmetric?," William Davidson Institute Working Papers Series wp1005, William Davidson Institute at the University of Michigan.
  3. Robert Ambrisko & Vitezslav Augusta & Jan Babecky & Michal Franta & Dana Hajkova & Petr Kral & Jan Libich & Pavla Netusilova & Milan Rikovsky & Jakub Rysanek & Pavel Soukup & Petr Stehlik & Vilem Vale, 2013. "Macroeconomic Effects of Fiscal Policy," Occasional Publications - Edited Volumes, Czech National Bank, Research Department, edition 2, volume 11, number rb11/2 edited by Jan Babecky & Kamil Galuscak.
  4. Cevik, Emrah Ismail & Dibooglu, Sel & Kutan, Ali M., 2013. "Measuring financial stress in transition economies," Journal of Financial Stability, Elsevier, vol. 9(4), pages 597-611.
  5. Albulescu, Claudiu Tiberiu, 2013. "Financial Stability and Monetary Policy: A Reduced-Form Model for the EURO Area," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(1), pages 62-81, March.
  6. Zdeněk Pavlík, 2012. "The Monetary Policy of the ECB in the Time of Crisis The Current Empirical Analysis," Současná Evropa, University of Economics, Prague, vol. 2012(1), pages 3-28.
  7. Jaromir Baxa & Michal Franta & Tomas Havranek & Roman Horvath & Miroslav Plasil & Marek Rusnak & Borek Vasicek, 2013. "Transmission of Monetary Policy," Occasional Publications - Edited Volumes, Czech National Bank, Research Department, edition 1, volume 11, number rb11/1 edited by Jan Babecky & Roman Horvath.

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