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Monetary Policy Rules and Financial Stress: Does Financial Instability Matter for Monetary

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  • Jaromír Baxa

    ()
    (Institute of Economic Studies, Charles University, Prague and Institute of Information Theory and Automation, Academy of Sciences of the Czech Republic)

  • Roman Horváth

    ()
    (Czech National Bank and Institute of Economic Studies, Charles University, Prague)

  • Borek Vasícek

    ()
    (Departament d'Economia Aplicada, Universitat Autonoma de Barcelona)

Abstract

We examine whether and how main central banks responded to episodes of financial stress over the last three decades. We employ a new methodology for monetary policy rules estimation, which allows for time-varying response coefficients as well as corrects for endogeneity. This flexible framework applied to the U.S., U.K., Australia, Canada and Sweden together with a new financial stress dataset developed by the International Monetary Fund allows not only testing whether the central banks responded to financial stress but also detects the periods and type of stress that were the most worrying for monetary authorities and to quantify the intensity of policy response. Our findings suggest that central banks often change policy rates: mainly decreasing it in the face of high financial stress. However, the size of a 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 regards 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 Department of Applied Economics at Universitat Autonoma of Barcelona in its series Working Papers with number wpdea1101.

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Length: 46 pages
Date of creation: Jan 2011
Date of revision:
Handle: RePEc:uab:wprdea:wpdea1101

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

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Cited by:
  1. Borek Vasicek, 2011. "Is Monetary Policy in the New EU Member States Asymmetric?," Working Papers 2011/05, Czech National Bank, Research Department.
  2. 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.
  3. 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.
  4. Kamil Galuscak & Adam Gersl & Marcela Gronychova & Petr Hlavac & Petr Jakubik & Lubos Komarek & Zlatuse Komarkova & Tomas Konecny & Jakub Seidler, 2014. "Stress-Testing Analyses of the Czech Financial System," Occasional Publications - Edited Volumes, Czech National Bank, Research Department, edition 1, volume 12, number rb12/1 edited by Jan Babecky & Roman Horvath, August.
  5. 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, August.
  6. Costas Milas, 2014. "Financial Stress and the Impact of Public Debt on UK Growth in High versus Low-Growth Regimes: 1850-2013," Working Paper Series 13_14, The Rimini Centre for Economic Analysis.
  7. Claudiu T Albulescu & Daniel Goyeau & Dominique Pépin, 2013. "Financial instability and ECB monetary policy," Economics Bulletin, AccessEcon, vol. 33(1), pages 388-400.
  8. 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.
  9. 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, August.

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