Monetary Policy and Financial (In)Stability: An Integrated Micro-Macro Approach

24 Pages Posted: 28 Feb 2007

See all articles by Ferre De Graeve

Ferre De Graeve

KU Leuven - Center for Economic Studies

Thomas K. Kick

Deutsche Bundesbank

Michael Koetter

Halle Institute for Economic Research

Date Written: February 2007

Abstract

Central banks focus on two objectives today: monetary and financial stability. Empirical evidence on this twin objective is scarce. We aim to contribute on the issue with an integrated micro-macro approach with two core virtues. First, we measure financial stability at the bank level for Europe's largest economy: Germany. Second, we specify a VAR model with feedback between the micro- and macroeconomic model components. This enables us to assess second round effects. Our results confirm the existence of a trade-off between monetary and financial stability. An unexpected tightening of monetary policy increases the mean probability of distress. This effect disappears when neglecting feedback effects, underlining the crucial importance of the former. Distress responses differ across banking groups and the severity of distress events. Hence, a more detailed account of heterogenous transmission dynamics beyond aggregate measures of financial stability is corroborated. An important policy implication is that the separation of financial supervision and monetary policy requires close collaboration among members in the European System of Central Banks and other national supervision authorities.

Keywords: financial stability, stress testing, bank distress, monetary policy

JEL Classification: E42, E52, E58, G21, G28

Suggested Citation

De Graeve, Ferre and Kick, Thomas K. and Koetter, Michael, Monetary Policy and Financial (In)Stability: An Integrated Micro-Macro Approach (February 2007). Available at SSRN: https://ssrn.com/abstract=966252 or http://dx.doi.org/10.2139/ssrn.966252

Ferre De Graeve

KU Leuven - Center for Economic Studies ( email )

Naamsestraat 69
Leuven, B-3000
Belgium

Thomas K. Kick

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

Michael Koetter (Contact Author)

Halle Institute for Economic Research ( email )

P.O. Box 11 03 61
Kleine Maerkerstrasse 8
D-06017 Halle, 06108
Germany

HOME PAGE: http://www.iwh-halle.de/en/about-the-iwh/people/detail/michael-koetter/