The Nexus Between Monetary Policy and Financial Stability
Friday, Jan. 5, 2018 8:00 AM - 10:00 AM
- Chair: Mark Gertler, New York University
Financial Vulnerability and Monetary Policy
AbstractWe present a microfounded New Keynesian model that features financial vulnerabilities. Financial intermediaries' occasionally binding value at risk constraints give rise to variation in the pricing of risk that generates time varying risk in the conditional mean and volatility of the output gap. The conditional mean and volatility are negatively related: during times of easy financial conditions, growth tends to be high, and risk tends to be low. Monetary policy affects output directly via the IS curve, and indirectly via the pricing of risk that relates to the tightness of the value at risk constraint. The optimal monetary policy rule always depends on financial vulnerabilities in addition to the output gap, inflation, and the natural rate. We show that a classic Taylor rule exacerbates deviations of the output gap from its target value of zero relative to an optimal interest rate rule that includes vulnerability. Simulations show that optimal policy significantly increases welfare relative to a classic Taylor rule. Alternative policy paths using historical examples illustrate the usefulness of the proposed policy rule.
A Quantitative Case for Leaning Against the Wind
AbstractShould a monetary authority lean against the build-up of financial imbalances? We study this policy question in an environment in which there are recurring cycles of financial imbalances that develop over time and eventually collapse in a costly manner. The optimal policy reflects the trade-off between the short-run macroeconomic costs of leaning against the wind and the longer-run benefits of stabilizing the financial cycle. We model the financial cycle as a nonlinear Markov regime-switching process, calibrate the model to US data and characterize the optimal monetary policy. Leaning systematically over the whole financial cycle is found to outperform policies of "benign neglect" and "late-in-the-cycle" discretionary interventions. This conclusion is robust to a wide range of alternative assumptions and supports an orientation shift in monetary policy frameworks away from narrow price stability to a joint consideration of price and financial stability.
Coordinating Monetary and Financial Regulatory Policies
AbstractHow to conduct macro-prudential regulation? How to coordinate monetary policy and macro-prudential policy? To address these questions, I develop a continuous-time New Keynesian economy in which a financial intermediary sector is subject to a leverage constraint. Coordination between monetary and macro-prudential policies helps to reduce the risk of entering into a financial crisis and speeds up exit from the crisis. The downside of coordination is variability in inflation and in the employment gap.
- E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit
- G0 - General