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Monetary policy tradeoffs between financial stability and price stability

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  • Malik Shukayev
  • Alexander Ueberfeldt

Abstract

We analyze the impact of interest rate policy on financial stability in an environment where banks can experience runs on their short-term liabilities forcing them to sell assets at fire-sale prices. Price adjustment frictions and a state-dependent risk of financial crisis create the possibility of a policy tradeoff between price stability and financial stability. Focusing on Taylor rules with monetary policy possibly reacting to banks short-term liabilities, we find that the optimized policy uses the extra tool to support investment at the expense of higher inflation and output volatility.

Suggested Citation

  • Malik Shukayev & Alexander Ueberfeldt, 2018. "Monetary policy tradeoffs between financial stability and price stability," Canadian Journal of Economics, Canadian Economics Association, vol. 51(3), pages 901-945, August.
    • Handle: RePEc:cje:issued:v:51:y:2018:i:3:p:901-945
    DOI: 10.1111/caje.12340
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    Cited by:

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    2. Nückles, Marc, 2020. "Interest rate policy and interbank market breakdown," Economic Modelling, Elsevier, vol. 91(C), pages 779-789.
    3. Akhmad Syakir Kurnia & Syahid Izzulhaq & Johan Beni Maharda & Agung Kunaedi, 2021. "Inflation and Financial Stability Trade‐off: Role of Monetary Policy Credibility and Fiscal Cyclicality," Economic Papers, The Economic Society of Australia, vol. 40(1), pages 31-53, March.

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    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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