Research Insights: Should Financial Stability Considerations Be Included in Monetary Policy Rules or Should They Be Addressed with Separate Financial Policy Rules?

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Oct 2020
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.