Monetary and Macroprudential Policy with Endogenous Risk

36 Pages Posted: 3 Mar 2020

See all articles by Tobias Adrian

Tobias Adrian

International Monetary Fund

Fernando Duarte

Federal Reserve Bank of New York

Nellie Liang

Brookings Institution

Pawel Zabczyk

International Monetary Fund MCMMP

Date Written: February 2020

Abstract

We extend the New Keynesian (NK) model to include endogenous risk. Lower interest rates not only shift consumption intertemporally but also conditional output risk via the impact on risk-taking, giving rise to a vulnerability channel of monetary policy. The model fits the conditional output gap distribution and can account for medium-term increases in downside risks when financial conditions are loose. The policy prescriptions are very different from those in the standard NK model: monetary policy that focuses purely on inflation and output-gap stabilization can lead to instability. Macroprudential measures can mitigate the intertemporal risk-return tradeoff created by the vulnerability channel.

Keywords: Macro-Finance, macroprudential policy, monetary policy

JEL Classification: E32, E44, E52, G28

Suggested Citation

Adrian, Tobias and Duarte, Fernando and Liang, Nellie and Zabczyk, Pawel, Monetary and Macroprudential Policy with Endogenous Risk (February 2020). CEPR Discussion Paper No. DP14435, Available at SSRN: https://ssrn.com/abstract=3547368

Tobias Adrian (Contact Author)

International Monetary Fund ( email )

Kuwait

Fernando Duarte

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

HOME PAGE: http://www.newyorkfed.org/research/economists/duarte/index.html

Nellie Liang

Brookings Institution ( email )

1775 Massachusetts Ave, NW
Washington, DC 20036
United States

Pawel Zabczyk

International Monetary Fund MCMMP ( email )

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

HOME PAGE: http://pawel.zabczyk.com

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