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

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  • Benjamin Käfer

    (University of Kassel)

Abstract

The question of whether central banks should bear responsibility for financial stability is still unan-swered. Regarding interest rate implementation, it is thus not clear if 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 developed 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 large 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

  • Benjamin Käfer, 2014. "The Taylor Rule and Financial Stability: A Literature Review with Application for the Eurozone," MAGKS Papers on Economics 201430, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
  • Handle: RePEc:mar:magkse:201430
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    File URL: http://www.uni-marburg.de/fb02/makro/forschung/magkspapers/30-2014_kaefer.pdf
    File Function: First 201430
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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.

    More about this item

    Keywords

    Taylor rule; financial stability; sovereign debt crisis; Eurozone heterogeneity; exchange rates; asset prices; credit spreads;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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