Board of Governors of the Federal Reserve System (US)
Finance and Economics Discussion Series
Financial Stability and Optimal Interest-Rate Policy
We study optimal interest-rate policy in a New Keynesian model in which the economy can experience financial crises and the probability of a crisis depends on credit conditions. The optimal adjustment to interest rates in response to credit conditions is (very) small in the model calibrated to match the historical relationship between credit conditions, output, inflation, and likelihood of financial crises. Given the imprecise estimates of key parameters, we also study optimal policy under parameter uncertainty. We find that Bayesian and robust central banks will respond more aggressively to financial instability when the probability and severity of financial crises are uncertain.
Cite this item
Andrea Ajello & Thomas Laubach & J. David Lopez-Salido & Taisuke Nakata, Financial Stability and Optimal Interest-Rate Policy, Board of Governors of the Federal Reserve System (US), Finance and Economics Discussion Series 2016-067, Aug 2016.
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
- G01 - Financial Economics - - General - - - Financial Crises
Keywords: Financial crises ; Financial stability and risk ; Leverage ; Monetary policy ; Optimal policy
This item with handle RePEc:fip:fedgfe:2016-67
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