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Monetary Policy Tradeoffs Between Financial Stability and Price Stability

Author

Listed:
  • Shukayev, Malik

    () (University of Alberta, Department of Economics)

  • Ueberfeldt, Alexander

    () (Bank of Canada)

Abstract

We analyze the impact of interest rate policy on financial stability in an environment where banks can experience runs on their short-term liabilities forcing them to sell assets at fire sale prices. Price adjustment frictions and a state-dependent risk of financial crisis create the possibility of a policy tradeoff between price stability and financial stability. Focusing on Taylor rules with monetary policy possibly reacting to banks' short-term liabilities, we find that the optimized policy uses the extra tool to support investment at the expense of higher inflation and output volatility.

Suggested Citation

  • Shukayev, Malik & Ueberfeldt, Alexander, 2016. "Monetary Policy Tradeoffs Between Financial Stability and Price Stability," Working Papers 2016-18, University of Alberta, Department of Economics.
  • Handle: RePEc:ris:albaec:2016_018
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    References listed on IDEAS

    as
    1. Jeremy C. Stein, 2012. "Monetary Policy as Financial Stability Regulation," The Quarterly Journal of Economics, Oxford University Press, vol. 127(1), pages 57-95.
    2. Andrea Ajello & Thomas Laubach & J. David Lopez-Salido & Taisuke Nakata, 2016. "Financial Stability and Optimal Interest-Rate Policy," Finance and Economics Discussion Series 2016-067, Board of Governors of the Federal Reserve System (US).
    3. Moritz Schularick & Alan M. Taylor, 2012. "Credit Booms Gone Bust: Monetary Policy, Leverage Cycles, and Financial Crises, 1870-2008," American Economic Review, American Economic Association, vol. 102(2), pages 1029-1061, April.
    4. Havranek, Tomas & Horvath, Roman & Irsova, Zuzana & Rusnak, Marek, 2015. "Cross-country heterogeneity in intertemporal substitution," Journal of International Economics, Elsevier, vol. 96(1), pages 100-118.
    5. Gorton, Gary B., 2012. "Misunderstanding Financial Crises: Why We Don't See Them Coming," OUP Catalogue, Oxford University Press, number 9780199922901.
    6. Carroll, Christopher D., 2006. "The method of endogenous gridpoints for solving dynamic stochastic optimization problems," Economics Letters, Elsevier, vol. 91(3), pages 312-320, June.
    7. Gorton, Gary & Metrick, Andrew, 2012. "Securitized banking and the run on repo," Journal of Financial Economics, Elsevier, vol. 104(3), pages 425-451.
    8. Svensson, Lars E.O., 2017. "Cost-benefit analysis of leaning against the wind," Journal of Monetary Economics, Elsevier, vol. 90(C), pages 193-213.
    9. Angeloni, Ignazio & Faia, Ester, 2013. "Capital regulation and monetary policy with fragile banks," Journal of Monetary Economics, Elsevier, vol. 60(3), pages 311-324.
    10. Claudio Borio, 2014. "Monetary policy and financial stability: what role in prevention and recovery?," BIS Working Papers 440, Bank for International Settlements.
    11. Sami Alpanda & Alexander Ueberfeldt, 2016. "Should Monetary Policy Lean Against Housing Market Booms?," Staff Working Papers 16-19, Bank of Canada.
    12. Julio J. Rotemberg, 1982. "Monopolistic Price Adjustment and Aggregate Output," Review of Economic Studies, Oxford University Press, vol. 49(4), pages 517-531.
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    More about this item

    Keywords

    Fire sales externality; short-term bank funding; business cycles; financial crisis;

    JEL classification:

    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • 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
    • G01 - Financial Economics - - General - - - Financial Crises

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