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Monetary Policy and Endogenous Financial Crises

Author

Listed:
  • Frederic Boissay
  • Fabrice Collard
  • Jordi Galí
  • Cristina Manea

Abstract

We study whether a central bank should deviate from its objective of price stability to promote financial stability. We tackle this question within a textbook New Keynesian model augmented with capital accumulation and microfounded endogenous financial crises. We compare several interest rate rules, under which the central bank responds more or less forcefully to inflation and aggregate output. Our main findings are threefold. First, monetary policy affects the probability of a crisis both in the short run (through aggregate demand) and in the medium run (through savings and capital accumulation). Second, a central bank can both reduce the probability of a crisis and increase welfare by departing from strict inflation targeting and responding systematically to fluctuations in output. Third, financial crises may occur after a long period of unexpectedly loose monetary policy as the central bank abruptly reverses course.

Suggested Citation

  • Frederic Boissay & Fabrice Collard & Jordi Galí & Cristina Manea, 2021. "Monetary Policy and Endogenous Financial Crises," NBER Working Papers 29602, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:29602
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    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Monetary Policy and Endogenous Financial Crises
      by Christian Zimmermann in NEP-DGE blog on 2022-02-06 04:40:28

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    3. Adam Hale Shapiro, 2022. "Decomposing Supply and Demand Driven Inflation," Working Paper Series 2022-18, Federal Reserve Bank of San Francisco.

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    More about this item

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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