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Financial Vulnerability and Monetary Policy

Author

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  • Fernando Duarte

    (Federal Reserve Bank of New York)

  • Tobias Adrian

    (Federal Reserve Bank of New York)

Abstract

We present a parsimonious New Keynesian model that features financial vulnerabilities. The vulnerabilities generate time varying downside risk of GDP growth by driving the dynamics of risk premia. Monetary policy impacts the output gap directly via the IS curve, and indirectly via its impact on financial vulnerabilities. The optimal monetary policy rule always depends on financial vulnerabilities in addition to output, inflation, and the real rate. We show that a classic Taylor rule exacerbates downside risk of GDP growth relative to an optimal Taylor rule, thus generating welfare losses associated with negative skewness of GDP growth.

Suggested Citation

  • Fernando Duarte & Tobias Adrian, 2017. "Financial Vulnerability and Monetary Policy," 2017 Meeting Papers 391, Society for Economic Dynamics.
    • Handle: RePEc:red:sed017:391
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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