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Financial Shocks and Optimal Monetary Policy Rules

Author

Listed:
  • Fabio Verona

    () (Bank of Finland, Monetary Policy and Research Department, and University of Porto, cef.up)

  • Manuel M. F. Martins

    (University of Porto, Faculty of Economics and cef.up)

  • Inês Drumond

    () (Banco de Portugal, Financial Stability Department, and University of Porto, cef.up)

Abstract

We assess the performance of optimal Taylor-type interest rate rules, with and without reaction to financial variables, in stabilizing the macroeconomy following financial shocks. We use a DSGE model that comprises both a loan and a bond market, which best suits the contemporary structure of the U.S. financial system and allows for a wide set of financial shocks and transmission mechanisms. Overall, we find that targeting financial stability – in particular credit growth, but in some cases also financial spreads and asset prices – improves macroeconomic stabilization. The specific policy implications depend on the policy regime, and on the origin and the persistence of the financial shock.

Suggested Citation

  • Fabio Verona & Manuel M. F. Martins & Inês Drumond, 2014. "Financial Shocks and Optimal Monetary Policy Rules," CEF.UP Working Papers 1402, Universidade do Porto, Faculdade de Economia do Porto.
  • Handle: RePEc:por:cetedp:1402
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Popoyan, Lilit & Napoletano, Mauro & Roventini, Andrea, 2017. "Taming macroeconomic instability: Monetary and macro-prudential policy interactions in an agent-based model," Journal of Economic Behavior & Organization, Elsevier, vol. 134(C), pages 117-140.
    2. Phuc Huynh & Trang Nguyen & Thanh Duong & Duc Pham, 2017. "Leaning against the Wind Policies on Vietnam’s Economy with DSGE Model," Economies, MDPI, Open Access Journal, vol. 5(1), pages 1-18, January.
    3. Lilit Popoyan & Mauro Napoletano & Andrea Roventini, 2019. "Winter is possibly not coming: Mitigating financial instability in an agent-based model with interbank market," LEM Papers Series 2019/11, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
    4. repec:zbw:ifweej:20187 is not listed on IDEAS
    5. 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.
    6. Crowley, Patrick & Hughes Hallett, Andrew, 2014. "Volatility transfers between cycles: A theory of why the "great moderation" was more mirage than moderation," Research Discussion Papers 23/2014, Bank of Finland.

    More about this item

    Keywords

    financial shocks; optimal monetary policy; Taylor rules; DSGE models; bond market; loan market;

    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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