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Monetary Policy Rules with Financial Instability

To provide a rigorous analysis of monetary policy in the face of financial instability, the authors extend the standard dynamic stochastic general equilibrium model to include a financial system. Their simulations suggest that if financial stability affects output and inflation with a lag, and if the central bank has privileged information about financial stability, then monetary policy responding instantly to deteriorating financial stability can trade off more output and inflation instability today for a faster return to the trend than a policy that follows the traditional Taylor rule. This augmented rule leads in some parameterizations to improved outcomes in terms of long-term welfare, but the welfare impacts of such a rule are small.

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Article provided by Charles University Prague, Faculty of Social Sciences in its journal Finance a uver - Czech Journal of Economics and Finance.

Volume (Year): 61 (2011)
Issue (Month): 6 (December)
Pages: 545-565

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Handle: RePEc:fau:fauart:v:61:y:2011:i:6:p:545-565
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  1. DellAriccia, Giovanni & Marquez, Robert, 2005. "Lending Booms and Lending Standards," CEPR Discussion Papers 5095, C.E.P.R. Discussion Papers.
  2. Stephen G. Cecchetti & Lianfa Li, 2008. "Do Capital Adequacy Requirements Matter For Monetary Policy?," Economic Inquiry, Western Economic Association International, vol. 46(4), pages 643-659, October.
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  4. Brousseau, Vincent & Detken, Carsten, 2001. "Monetary policy and fears of financial instability," Working Paper Series 0089, European Central Bank.
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  9. Jordi Gali, 2002. "New Perspectives on Monetary Policy, Inflation, and the Business Cycle," NBER Working Papers 8767, National Bureau of Economic Research, Inc.
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  11. 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.
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  13. 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.
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  17. Martin Fukac & Adrian Pagan, 2006. "Issues in Adopting DSGE Models for Use in the Policy Process," Working Papers 2006/6, Czech National Bank, Research Department.
  18. 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.
  19. Michael Taylor & Marc Quintyn & Silvia Ramirez, 2007. "The Fear of Freedom: Politicians and the Independence and Accountability of Financial Sector Supervisors," IMF Working Papers 07/25, International Monetary Fund.
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  22. Martin Cihák, 2006. "How Do Central Banks Writeon Financial Stability?," IMF Working Papers 06/163, International Monetary Fund.
  23. Shin, Hyun Song, 2002. "Comments on "How good is the market at assessing bank fragility? A horse race between different indicators"," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 1029-1031, May.
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