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Quantifying financial stability risks for monetary policy

Author

Listed:
  • Chavleishvili, Sulkhan
  • Kremer, Manfred
  • Lund-Thomsen, Frederik

Abstract

When inflationary pressures started intensifying in 2022, the world’s major central banks faced a dilemma. They could rapidly tighten monetary policy at the risk of fuelling financial distress after years of ultra-low interest rates and balance sheet expansion. Or they could take a more gradual approach to fighting inflation that would protect the financial system, but risk high inflation becoming entrenched. While severe financial instability may be an unlikely event (or “tail risk”), it can have devastating macroeconomic consequences. Quantifying financial stability trade-offs therefore requires a way to gauge the three-way interaction between monetary policy, financial stability conditions and tail risks to the economy. JEL Classification: C32, E37, E44, E52, G01

Suggested Citation

  • Chavleishvili, Sulkhan & Kremer, Manfred & Lund-Thomsen, Frederik, 2024. "Quantifying financial stability risks for monetary policy," Research Bulletin, European Central Bank, vol. 115.
    • Handle: RePEc:ecb:ecbrbu:2024:0115:
    Note: 92197
    as

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    References listed on IDEAS

    as
    1. Acharya, Viral & Rajan, Raghuram & Steffen, Sascha & Chauhan, Rahul, 2022. "Liquidity Dependence and the Waxing and Waning of Central Bank Balance Sheets," CEPR Discussion Papers 17622, C.E.P.R. Discussion Papers.
    2. Lutz Kilian & Simone Manganelli, 2008. "The Central Banker as a Risk Manager: Estimating the Federal Reserve's Preferences under Greenspan," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(6), pages 1103-1129, September.
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    More about this item

    Keywords

    cost-benefit analysis; financial stability; growth-at-risk; Monetary policy trade-offs; systemic risk;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G01 - Financial Economics - - General - - - Financial Crises

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