Taylor Rule Under Financial Instability

By Martin Cihak, Ales Bulir, Sofía Bauducco

January 1, 2008

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Format: Chicago

Martin Cihak, Ales Bulir, and Sofía Bauducco. Taylor Rule Under Financial Instability, (USA: International Monetary Fund, 2008) accessed November 21, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper contributes to the analysis of monetary policy in the face of financial instability. In particular, we extend the standard new Keynesian dynamic stochastic general equilibrium (DSGE) model with sticky prices to include a financial system. Our simulations suggest that if financial instability affects output and inflation with a lag and if the central bank has privileged information about credit risk, monetary policy that responds instantly to increased credit risk can trade off more output and inflation instability today for a faster return to the trend than a policy that follows the simple Taylor rule with only the contemporaneous output gap and inflation.

Subject: Banking, Central bank policy rate, Financial sector, Loans, Technology

Keywords: Financial system, Goods firm, Monetary policy, Output gap, WP

Publication Details

Pages:

41
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2008/018
Stock No:

WPIEA2008018
ISBN:

9781451868807
ISSN:

1018-5941

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