Monetary Policy and Capital Regulation in the US and Europe

41 Pages Posted: 19 Jul 2010

See all articles by Ethan Cohen-Cole

Ethan Cohen-Cole

Econ One Research

Jonathan Morse

Federal Reserve Banks - Federal Reserve Bank of Boston

Date Written: June 24, 2010

Abstract

From the onset of the 2007-2009 crisis, the Federal Reserve and the European Central Bank have aggressively lowered interest rates. Both sets of changes are at odds with an anti-inflationary stance of monetary policy; indeed, as the crisis began in August 2007 inflation expectations were high and rising, particularly in the United States. We have two additions to the literature. One, we present a model economy with a leveraged and regulated financial sector. Two, we find optimal Taylor rules for our economy that are consistent with a strong pro-inflationary reaction during financial crisis while maintaining a standard output-inflation mandate. We have three interpretations of our results. One, because the Federal Reserve has partial control over bank regulation it can exercise regulatory lenience. Two, the Fed’s stronger output orientation means that it will potentially respond more quickly when faced with constrained banks. Three, our results support procyclical capital regulation.

Keywords: monetary policy, capital regulation, crisis

JEL Classification: E52, E58, G18, G28

Suggested Citation

Cohen-Cole, Ethan and Morse, Jonathan, Monetary Policy and Capital Regulation in the US and Europe (June 24, 2010). ECB Working Paper No. 1222. Available at SSRN: https://ssrn.com/abstract=1629829

Ethan Cohen-Cole (Contact Author)

Econ One Research ( email )

United States

Jonathan Morse

Federal Reserve Banks - Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

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