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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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