Monetary Policy and Financial Stability
39 Pages Posted: 28 Mar 2023
Date Written: March 19, 2023
How should monetary policy respond to deteriorating financial conditions? We develop and estimate a dynamic new Keynesian model with financial intermediaries and sticky long-term corporate leverage to show that active response to movements in credit conditions helps to mitigate losses in aggregate consumption and output associated with macro fluctuations. A (credible) monetary policy rule that includes credit spreads is thus welfare-improving, sometimes even obviating the need for explicit inflation targeting.
Keywords: Credit spreads, monetary policy rules, financial stability
JEL Classification: E12, E43, E44, E52, G32
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