Monetary Policy Rules with Financial Instability

08  February 2010    5:15 pm

Ales Bulir, IMF


wiiw, Rahlgasse 3, 1060 Vienna, lecture hall (entrance from the ground floor)


The presentation is based on a paper written with co-authors Sofia Bauducco and Martin Cihak. To provide a rigorous analysis of monetary policy in the face of financial instability, we extend the standard dynamic stochastic general equilibrium model to include a financial system. Our simulations suggest that if financial instability affects output and inflation with a lag, and if the central bank has privileged information about credit risk, monetary policy responding instantly to increased credit risk can trade off more output and inflation instability today for a faster return to the trend than a policy that follows the simple Taylor rule. This augmented rule leads in some parameterizations to improved outcomes in terms of long-term welfare, however, the welfare impacts of such a rule appear to be negligible.