Central Bank Financial Strength and Credibility: A Simple Dynamic Optimization Model
In this paper, we develop a simple dynamic optimization model of a central bank, in which the bank’s profit affects its balance sheet. The model derives the transversality condition that is necessary for a central bank to be sustainable and to conduct an optimal monetary policy. In this sense, the transversality condition needs to be satisfied to maintain central bank credibility. We discuss some factors affecting the transversality condition and show that what is important to satisfy the condition and thus to maintain central bank credibility is not capital alone but the financial strength that generates no sustained loss.
|Date of creation:||Mar 2013|
|Date of revision:||Mar 2013|
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