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Taylor Rule Under Financial Instability

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Author Info
Martin Cihák
Sofia Bauducco
Ales Bulir

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Abstract

This paper contributes to the analysis of monetary policy in the face of financial instability. In particular, we extend the standard new Keynesian dynamic stochastic general equilibrium (DSGE) model with sticky prices to include a financial system. Our simulations suggest that if financial instability affects output and inflation with a lag and if the central bank has privileged information about credit risk, monetary policy that responds instantly to increased credit risk can trade off more output and inflation instability today for a faster return to the trend than a policy that follows the simple Taylor rule with only the contemporaneous output gap and inflation.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 08/18.

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Length: 41 pages
Date of creation: 30 Jan 2008
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Handle: RePEc:imf:imfwpa:08/18

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Related research
Keywords: Monetary policy Inflation Credit risk Financial stability

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References listed on IDEAS
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  1. Carsten Detken & Vincent Brousseau, 2001. "Monetary policy and fears of financial instability," Working Paper Series 089, European Central Bank. [Downloadable!]
  2. Bordo, Michael D & Jeanne, Olivier, 2002. "Boom-Busts in Asset Prices, Economic Instability and Monetary Policy," CEPR Discussion Papers 3398, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  3. Bernanke, B. & Gertler, M. & Gilchrist, S., 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," Working Papers 98-03, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
    Other versions:
  4. Martin Fukac & Adrian Pagan, 2006. "Issues In Adopting Dsge Models For Use In The Policy Process," CAMA Working Papers 2006-10, Australian National University, Centre for Applied Macroeconomic Analysis. [Downloadable!]
    Other versions:
  5. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December. [Downloadable!] (restricted)
  6. Lars E. O. Svensson, 2003. "What Is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 426-477, June.
    Other versions:
  7. Bongini, Paola & Laeven, Luc & Majnoni, Giovanni, 2002. "How good is the market at assessing bank fragility? A horse race between different indicators," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 1011-1028, May. [Downloadable!] (restricted)
  8. Stephen G. Cecchetti & Lianfi Li, 2005. "Do Capital Adequacy Requirements Matter for Monetary Policy?," NBER Working Papers 11830, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. Claudio E. V. Borio, 2006. "Monetary and prudential policies at a crossroads? New challenges in the new century," BIS Working Papers 216, Bank for International Settlements. [Downloadable!]
  10. Galí, Jordi, 2002. "New Perspectives on Monetary Policy, Inflation and the Business Cycle," CEPR Discussion Papers 3210, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  11. Boorman, Jack & Lane, Timothy & Schulze-Ghattas, Marianne & Bulir, Ales & Ghosh, Atish R. & Hamann, Javier & Mourmouras, Alex & Phillips, Steven, 2000. "Managing financial crises: the experience in East Asia," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 53(1), pages 1-67, December. [Downloadable!] (restricted)
    Other versions:
  12. Ben Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Proceedings, Federal Reserve Bank of Kansas City, pages 77-128. [Downloadable!]
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  13. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September. [Downloadable!] (restricted)
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