Trading off monetary and financial stability: a balance of risk framework
AbstractThis paper presents a framework that quantifies the trade-offs for a central bank that includes financial stability in its strategy and uses macroprudential instruments next to the interest rate. It is an innovative application of the Kaminsky and Reinhart early warning method, by assuming that the central bank takes into account financial variables as signals of inflation risks. The empirical application shows that trading off monetary and macroprudential policy reduces the overall costs related to inflation and financial instability. This can be achieved by changing the preferences of the central bank, lengthening the monetary policy horizon and by a more flexible inflation target. Estimation results of a probit model indicate that the monetary stance in the US and the Euro area has not adequately traded off price stability against financial stability.
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Bibliographic InfoPaper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 249.
Date of creation: May 2010
Date of revision:
financial stability; macroprudential policy; monetary policy; policy co-ordination; inflation;
Find related papers by JEL classification:
- E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-05-15 (All new papers)
- NEP-CBA-2010-05-15 (Central Banking)
- NEP-MAC-2010-05-15 (Macroeconomics)
- NEP-MON-2010-05-15 (Monetary Economics)
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