Optimal Simple Objectives for Monetary Policy when Banks Matter
57 Pages Posted: 25 Nov 2020
Date Written: November 20, 2020
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: Suggested Citation