Optimal Simple Objectives for Monetary Policy when Banks Matter

57 Pages Posted: 25 Nov 2020

See all articles by Lien Laureys

Lien Laureys

Bank of England

Roland Meeks

International Monetary Fund

Boromeus Wanengkirtyo

Bank of England

Multiple version iconThere are 3 versions of this paper

Date Written: November 20, 2020

Abstract

We reconsider the design of welfare-optimal monetary policy when financing frictions impair the supply of bank credit, and when the objectives set for monetary policy must be simple enough to be implementable and allow for effective accountability. We show that a flexible inflation targeting approach that places weight on stabilising inflation, a measure of resource utilisation, and a financial variable produces welfare benefits that are almost indistinguishable from fully-optimal Ramsey policy. The macro-financial trade-off in our estimated model of the euro area turns out to be modest, implying that the effects of financial frictions can be ameliorated at little cost in terms of inflation. A range of different financial objectives and policy preferences lead to similar conclusions.

Keywords: Monetary policy, simple loss function, banks, medium-scale DSGE models, euro area economy

JEL Classification: E17, E52, E58, G21

Suggested Citation

Laureys, Lien and Meeks, Roland and Wanengkirtyo, Boromeus, Optimal Simple Objectives for Monetary Policy when Banks Matter (November 20, 2020). Bank of England Working Paper No. 890, Available at SSRN: https://ssrn.com/abstract=3736974 or http://dx.doi.org/10.2139/ssrn.3736974

Lien Laureys (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Roland Meeks

International Monetary Fund ( email )

Kuwait

Boromeus Wanengkirtyo

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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