Monetary policy and fears of financial instability
Abstract
Exploiting a specific sunspot equilibrium in a standard forward-looking New Keynsian model, we present an example of a possible conflict between short-term price stability and financial stability. We find a conflict because the sunspot process consists of a self-fulfilling belief linking the stability of inflation to the smoothness of the interest rate path. A policy focusing only on a fixed-horizon inflation forecast neglects the potential effects of this belief on the variance of inflation. The nature of the conflict case is interpreted as evidence for the occasional relevance as well as the general tenuousness of the conflict case. The implementation of our example has led us, furthermore, to illustrate the lack of general applicability of the Bellman principle in dynamic programming for forward-looking models. Our result holds with respect to a more general (Nash-type) concept of optimality. JEL Classification: C61; C62; E52; E58.Download Info
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Paper provided by European Central Bank in its series Working Paper Series with number 089.Length: 46 pages
Date of creation: Nov 2001
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Handle: RePEc:ecb:ecbwps:20010089
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Related research
Keywords: Financial stability; price stability; optimal monetary policy; sunspot equilibria; Bellman principle; time inconsistency.;Find related papers by JEL classification:
- C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
- C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
References
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Citations
Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.Cited by:
- Jaromír Baxa & Roman Horváth & Borek Vasícek, 2011.
"Monetary Policy Rules and Financial Stress: Does Financial Instability Matter for Monetary,"
Working Papers
wpdea1101, Department of Applied Economics at Universitat Autonoma of Barcelona.
- Jaromir Baxa & Roman Horvath & Borek Vasicek, 2011. "Time-Varying Monetary-Policy Rules and Financial Stress: Does Financial Instability Matter for Monetary Policy?," Working Papers 2011/03, Czech National Bank, Research Department.
- Sofía Bauducco & Aleš Bulíø & Martin Èihák, 2011.
"Monetary Policy Rules with Financial Instability,"
Czech Journal of Economics and Finance (Finance a uver),
Charles University Prague, Faculty of Social Sciences, vol. 61(6), pages 545-565, December.
- Sofia Bauducco & Ales Bulir & Martin Cihak, 2008. "Monetary Policy Rules with Financial Instability," Working Papers 2008/8, Czech National Bank, Research Department.
- Martin Cihák & Ales Bulir & SofÃa Bauducco, 2008. "Taylor Rule Under Financial Instability," IMF Working Papers 08/18, International Monetary Fund.
- Uhlig, H.F.H.V.S., 2002.
"One Money, But Many Fiscal Policies in Europe: What are the Consequences?,"
Discussion Paper
2002-32, Tilburg University, Center for Economic Research.
- Uhlig, Harald, 2002. "One Money, but Many Fiscal Policies in Europe: What Are the Consequences?," CEPR Discussion Papers 3296, C.E.P.R. Discussion Papers.
- Claudiu Tiberiu ALBULESCU, 2011. "Macro-Financial Risks and Central Banks: What Changes Has the Crisis Triggered?," Timisoara Journal of Economics, West University of Timisoara, Romania, Faculty of Economics and Business Administration, vol. 4(3(15)), pages 135-142.
- Carsten Detken & Frank Smets, 2004. "Asset price booms and monetary policy," Working Paper Series 364, European Central Bank.
- Bank for International Settlements, 2003. "Monetary stability, financial stability and the business cycle: five views," BIS Papers, Bank for International Settlements, number 18, March.
- Carsten Detken & Vitor Gaspar, 2003. "Maintaining price stability under free-floating: a fearless way out of the corner?," Working Paper Series 241, European Central Bank.
- Baxa, Jaromír & Horváth, Roman & Vašíček, Bořek, 2013.
"Time-varying monetary-policy rules and financial stress: Does financial instability matter for monetary policy?,"
Journal of Financial Stability,
Elsevier, vol. 9(1), pages 117-138.
- Jaromir Baxa & Roman Horvath & Borek Vasicek, 2011. "Time-Varying Monetary-Policy Rules and Financial Stress: Does Financial Instability Matter for Monetary Policy?," Working Papers 2011/03, Czech National Bank, Research Department.
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