Monetary Policy and Financial Stability

Abstract

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.

Presented at: Vanderbilt University*, Society for Economic Dynamics, Central Bank Research Association, China International Conference in Finance, European Finance Association, American Finance Association (scheduled)

*denotes presentation by co-author

Mentioned by: Knowledge@Wharton