Financial Shocks and Optimal Monetary Policy Rules
49 Pages Posted: 14 Oct 2014
Date Written: July 25, 2014
We assess the performance of optimal Taylor-type interest rate rules, with and without reaction to financial variables, in stabilizing the macroeconomy following financial shocks. We use a DSGE model that comprises both a loan and a bond market, which best suits the contemporary structure of the U.S. financial system and allows for a wide set of financial shocks and transmission mechanisms. Overall, we find that targeting financial stability – in particular credit growth, but in some cases also financial spreads and asset prices – improves macroeconomic stabilization. The specific policy implications depend on the policy regime, and on the origin and the persistence of the financial shock.
Keywords: financial shocks, optimal monetary policy, Taylor rules, DSGE models, bond market, loan market
JEL Classification: E32, E44, E52
Suggested Citation: Suggested Citation