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The Taylor Rule and Financial Stability – A Literature Review with Application for the Eurozone

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  • Käfer Benjamin

    () (University of Kassel, Department of Economics, Nora-Platiel-Str. 4, 34127 Kassel, Germany)

Abstract

The question whether central banks should bear responsibility for financial stability remains unanswered. In connection with the use of interest rates, it is therefore not clear whether and how the Taylor rule should be augmented by an additional financial stability term. This paper reviews the normative and positive literature on Taylor rules augmented with exchange rates, asset prices, credit, and spreads. These measures have evolved as common indicators of financial (in)stability in the Taylor rule literature. In addition, our own analysis describes the development of these indicators for the core and the periphery of the Eurozone. Given the high degree of heterogeneity between euro area countries, the conclusion here is that an interest rate reaction to instability by the European Central Bank would be inappropriate in times of crisis. However, this conclusion is somewhat weakened if there is no crisis.

Suggested Citation

  • Käfer Benjamin, 2014. "The Taylor Rule and Financial Stability – A Literature Review with Application for the Eurozone," Review of Economics, De Gruyter, vol. 65(2), pages 159-192, August.
  • Handle: RePEc:lus:reveco:v:65:y:2014:i:2:p:159-192
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    Cited by:

    1. Krug, Sebastian, 2015. "The interaction between monetary and macroprudential policy: Should central banks "lean against the wind" to foster macrofinancial stability?," Economics Working Papers 2015-08, Christian-Albrechts-University of Kiel, Department of Economics.
    2. Raputsoane, Leroi, 2018. "Targeting financial stress as opposed to the exchange rate," MPRA Paper 84865, University Library of Munich, Germany.

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