Financial Shocks and Optimal Monetary Policy Rules

49 Pages Posted: 14 Oct 2014  

Fabio Verona

Bank of Finland - Research

Manuel M. F. Martins

University of Porto, CEMPRE, Faculdade de Economia

Inês Drumond

Universidade do Porto - Faculdade de Economia (FEP)

Date Written: July 25, 2014

Abstract

​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

Verona, Fabio and Martins, Manuel M. F. and Drumond, Inês, Financial Shocks and Optimal Monetary Policy Rules (July 25, 2014). Bank of Finland Research Discussion Paper No. 21/2014. Available at SSRN: https://ssrn.com/abstract=2509187 or http://dx.doi.org/10.2139/ssrn.2509187

Fabio Verona (Contact Author)

Bank of Finland - Research ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland

HOME PAGE: http://bofcris.solenovo.fi/crisyp/disp/_/en/cr_redir_all/fet/fet/sea?direction=3&id=3827426

Manuel Mota Freitas Martins

University of Porto, CEMPRE, Faculdade de Economia ( email )

4200-464 Porto
Portugal

Inês Drumond

Universidade do Porto - Faculdade de Economia (FEP) ( email )

Porto
Portugal

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