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Optimal Monetary Policy Rules, Financial Amplification, and Uncertain Business Cycles

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  • Salih Fendoglu

Abstract

This paper studies whether financial variables per se should matter for monetary policy. Earlier consensus view - using financial amplification models with disturbances that have no direct effect on credit market conditions- suggests that financial variables should not be assigned an independent role in policy making. Introducing uncertainty, time- variation in cross-sectional dispersion of firms’ productive performance, alters this policy prescription. The results show that (i) optimal policy is to dampen the strength of financial amplification by responding to uncertainty (at the expense of creating a mild degree of fluctuations in inflation). Moreover, a higher uncertainty makes the planner more willing to relax the financial constraints. (ii) Credit spreads are a good proxy for uncertainty, and hence, within the class of simple monetary policy rules I consider, a non-negligible response to credit spreads -together with a strong anti-inflationary stance- achieves the highest aggregate welfare possible.

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  • Salih Fendoglu, 2011. "Optimal Monetary Policy Rules, Financial Amplification, and Uncertain Business Cycles," Working Papers 1126, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
  • Handle: RePEc:tcb:wpaper:1126
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    Cited by:

    1. Mahir Binici & Hasan Erol & A. Hakan Kara & Pinar Ozlu & Deren Unalmis, 2013. "Interest Rate Corridor : A New Macroprudential Tool?," CBT Research Notes in Economics 1320, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
    2. Ahmet Aysan & Salih Fendoglu & Mustafa Kilinc, 2014. "Managing short-term capital flows in new central banking: unconventional monetary policy framework in Turkey," Eurasian Economic Review, Springer;Eurasia Business and Economics Society, vol. 4(1), pages 45-69, June.
    3. Piero Ferri & Annalisa Cristini & Anna Maria Variato, 2016. "Endogenous fluctuations, markups, capacity and credit constraints," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 11(2), pages 273-292, October.
    4. Don Bredin & Stilianos Fountas, 2018. "US Inflation and Inflation Uncertainty Over 200 Years," Discussion Paper Series 2018_04, Department of Economics, University of Macedonia, revised Apr 2018.
    5. Roos, Michael W. M., 2015. "The macroeconomics of radical uncertainty," Ruhr Economic Papers 592, RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
    6. Alessandro Notarpietro & Stefano Siviero, 2015. "Optimal Monetary Policy Rules and House Prices: The Role of Financial Frictions," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 47(S1), pages 383-410, March.
    7. Francesco Furlanetto & Paolo Gelain & Marzie Taheri Sanjani, 2014. "Output Gap in Presence of Financial Frictions and Monetary Policy Trade-offs," IMF Working Papers 14/128, International Monetary Fund.
    8. Grimme, Christian, 2017. "Uncertainty and the Cost of Bank vs. Bond Finance," MPRA Paper 79852, University Library of Munich, Germany.
    9. repec:spr:pharme:v:4:y:2014:i:1:p:45-69 is not listed on IDEAS

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    Keywords

    Optimal Monetary Policy; Financial Amplification; Uncertainty Shocks;

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