The Reaction Function Channel of Monetary Policy and the Financial Cycle

42 Pages Posted: 8 Oct 2019

See all articles by Andrew J. Filardo

Andrew J. Filardo

Bank for International Settlements (BIS) - Monetary and Economic Department

Paul Hubert

OFCE - Sciences Po

Phurichai Rungcharoenkitkul

Bank for International Settlements (BIS) - Monetary and Economic Department

Date Written: October 2, 2019

Abstract

This paper examines whether monetary policy reaction function matters for financial stability. We measure how responsive the Federal Reserve's policy appears to be to imbalances in the equity, housing and credit markets. We find that changes in these policy sensitivities predict the later development of financial imbalances. When monetary policy appears to respond more countercyclically to market overheating, imbalances tend to decline over time. This effect is distinct from that of current and anticipated interest rate levels - the risk-taking channel. The evidence highlights the importance of a "policy reaction function" channel of monetary policy in shaping the financial cycle.

Keywords: policy reaction function channel, asset price booms, credit booms, monetary policy, financial cycles, time-varying models

JEL Classification: E50, E52, G00, G01, G12

Suggested Citation

Filardo, Andrew J. and Hubert, Paul and Rungcharoenkitkul, Phurichai, The Reaction Function Channel of Monetary Policy and the Financial Cycle (October 2, 2019). BIS Working Paper No. 816. Available at SSRN: https://ssrn.com/abstract=3463900

Andrew J. Filardo (Contact Author)

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Paul Hubert

OFCE - Sciences Po ( email )

10 place de Catalogne
Paris 75014
France

Phurichai Rungcharoenkitkul

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

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