Monetary Policy When the Central Bank Shapes Financial-Market Sentiment

30 Pages Posted: 19 Dec 2022 Last revised: 10 Jul 2023

See all articles by Anil K. Kashyap

Anil K. Kashyap

University of Chicago, Booth School of Business; National Bureau of Economic Research (NBER); Federal Reserve Bank of Chicago

Jeremy C. Stein

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

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Date Written: December 2022

Abstract

Recent research has found that monetary policy works in part by influencing the risk premiums on both traded financial-market securities and intermediated loans. Research has also shown that when risk premiums are compressed, there is an increased likelihood of a reversal that damages the credit-supply mechanism and the real economy. Together these effects create an intertemporal tradeoff for monetary policy, as stimulating the economy today can sow the seeds of a future downturn that might be difficult to offset. We introduce a simple model of this tradeoff and draw out its implications for the conduct of monetary policy.

Suggested Citation

Kashyap, Anil K. and Stein, Jeremy C., Monetary Policy When the Central Bank Shapes Financial-Market Sentiment (December 2022). NBER Working Paper No. w30751, Available at SSRN: https://ssrn.com/abstract=4306705

Anil K. Kashyap (Contact Author)

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