Systemic Risk: A New Trade-Off for Monetary Policy?

Riksbank Research Paper Series No. 165

Sveriges Riksbank Working Paper Series No. 341

46 Pages Posted: 26 Jan 2018

See all articles by Stefan Laseen

Stefan Laseen

Sveriges Riksbank - Monetary Policy Department

Andreas Pescatori

International Monetary Fund (IMF)

Jarkko Turunen

International Monetary Fund

Multiple version iconThere are 2 versions of this paper

Date Written: August 2017

Abstract

We introduce time-varying systemic risk (à la He and Krishnamurthy, 2014) in an otherwise standard New-Keynesian model to study whether simple leaning-against-the-wind interest rate rules can reduce systemic risk and improve welfare. We find that while financial sector leverage contains additional information about the state of the economy that is not captured in inflation and output leaning against financial variables can only marginally improve welfare because rules are detrimental in the presence of falling asset prices. An optimal macroprudential policy, similar to a countercyclical capital requirement, can eliminate systemic risk raising welfare by about 1.5%. Also, a surprise monetary policy tightening does not necessarily reduce systemic risk, especially during bad times. Finally, a volatility paradox a la Brunnermeier and Sannikov (2014) arises when monetary policy tries to excessively stabilize output.

Keywords: Monetary Policy, Endogenous Financial Risk, DSGE models, Non-Linear Dynamics, Policy Evaluation

JEL Classification: E3, E52, E58, E44, E61, G2, G12

Suggested Citation

Laseen, Stefan and Pescatori, Andreas and Turunen, Jarkko, Systemic Risk: A New Trade-Off for Monetary Policy? (August 2017). Riksbank Research Paper Series No. 165. Available at SSRN: https://ssrn.com/abstract=3079669 or http://dx.doi.org/10.2139/ssrn.3079669

Stefan Laseen (Contact Author)

Sveriges Riksbank - Monetary Policy Department ( email )

S-103 37 Stockholm
Sweden

Andreas Pescatori

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Jarkko Turunen

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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