Financial shocks, financial stability, and optimal Taylor rules

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Title: Financial shocks, financial stability, and optimal Taylor rules
Author: Verona, Fabio ; Martins, Manuel M. F. ; Drumond, Inês
Organization: Bank of Finland
Series: Bank of Finland Research Discussion Papers
Series year: 2014
Series number: 21/2014
Year of publication: 2014
Publication date: 26.8.2014
Published in: Published online-first (April 2017) in the Journal of Macroeconomics, special issue on “Banking in macroeconomic theory and policy”
Pages: 59
Subject (yso): rahapolitiikka; rahoitusmarkkinat; vakaus; luotot
Keywords: säännöt; mallit; häiriöt; korot; joukkovelkakirjat; USA
Abstract: We assess the performance of optimal Taylor-type interest rate rules, with and without reaction to financial variables, in stabilizing an economy following financial shocks. The analysis is conducted in a DSGE model with loan and bond markets, each featuring financial frictions. This allows for a wide set of financial shocks and transmission mechanisms and can be calibrated to match the bond-to-bank finance ratio featured in the US financial system. Overall, we find that monetary policy that reacts to credit growth, a form of the so-called “leaning against the wind”, improves the ability of the central bank to achieve its mandate in the wake of financial shocks. The specific policy implications depend partly on the origin and the persistence of the financial shock, but overall not on the assignment of a mandate for financial stability in the central bank’s objective function. Keywords: financial shocks, optimal monetary policy, Taylor rules, DSGE models, bond market, loan market JEL codes: E32, E44, E52
Note: Päivitetty versio lisätty 27.6.2017Revised version uploaded 27 June 2017

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