Collard, Fabrice, Boissay, Frédéric, Galí, Jordi and Manea, Cristina (2023) Monetary Policy and Endogenous Financial Crises. TSE Working Paper, n. 21-1277, Toulouse, France

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Should a central bank deviate from price stability to promote financial stability? We study this question through the lens of a textbook New Keynesian model augmented with capital accumulation and search–for–yield behaviors that give rise to endogenous financial crises. Our main findings are fourfold. First, monetary policy affects the probability of a crisis both in the short run (through aggregate demand) and in the medium run (through savings and capital accumulation). Second, the central bank can lower the probability of a crisis and increase welfare compared to strict inflation targeting by responding to output and an index of financial fragility (the “yield gap”) in addition to inflation. Third, “backstop” policy rules that prevent credit market collapses can further increase welfare. Fourth, financial crises may occur after a long period of unexpectedly loose monetary policy as the central bank abruptly reverses course.

Item Type: Monograph (Working Paper)
Language: English
Date: April 2023
Place of Publication: Toulouse, France
JEL Classification: E1 - General Aggregative Models
E3 - Prices, Business Fluctuations, and Cycles
E6 - Macroeconomic Policy Formation, Macroeconomic Aspects of Public Finance, Macroeconomic Policy, and General Outlook
Divisions: TSE-R (Toulouse)
Institution: Université Toulouse 1 Capitole
Site: UT1
Date Deposited: 04 Jan 2022 08:02
Last Modified: 21 Apr 2023 12:26
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