Research Insights: Should Financial Stability Considerations Be Included in Monetary Policy Rules or Should They Be Addressed with Separate Financial Policy Rules?
Peer Reviewed
Date issued
October 2020
Publication
Subject
Inflation;
Monetary Policy;
Financial Policy;
Financial Friction;
Financial Market;
Interest Rate;
Financial Regulation;
Financial Stability
JEL code
E52 - Monetary Policy;
E58 - Central Banks and Their Policies;
E44 - Financial Markets and the Macroeconomy
Category
Catalogs and Brochures
Countries should have two different rules: a monetary policy rule for inefficiency in adjusting prices, and a financial policy rule for inefficiencies originating in financial markets. A two-rule regime entails lower welfare costs than either a Taylor rule, which reacts to inflation, or a Taylor rule augmented with financial considerations. When two rules are used, the Nash equilibrium is better than a Taylor rule or an augmented Taylor rule, but worse than a cooperative equilibrium.
