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Monetary Rules, Financial Stability and Welfare in a non-Ricardian Framework

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  • Adame Espinosa Francisco

Abstract

This work is based on a new Keynesian theoretical model for an advanced economy, which incorporates overlapping generations to analyze a channel through which fluctuations in household financial wealth influence aggregate demand. The optimal monetary policy, corresponding to that of a central planner maximizing households' welfare, aims to mitigate financial fluctuations while simultaneously reducing variability in inflation and the output gap. The model is calibrated for the United States and reproduces the effect of variations in the price of financial assets on aggregate demand. The results show, first, that in the presence of productivity, financial, and demand shocks, optimal monetary policy significantly improves aggregate welfare by stabilizing financial fluctuations that impact households' wealth. Secondly, in the face of productivity and financial shocks, an augmented monetary rule responding explicitly to fluctuations in the price of financial assets, in addition to inflation and output gaps, can reproduce the welfare achieved under optimal monetary policy. However, this is not the case for demand shocks.

Suggested Citation

  • Adame Espinosa Francisco, 2023. "Monetary Rules, Financial Stability and Welfare in a non-Ricardian Framework," Working Papers 2023-14, Banco de México.
    • Handle: RePEc:bdm:wpaper:2023-14
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    File URL: https://www.banxico.org.mx/publications-and-press/banco-de-mexico-working-papers/%7B033E4587-A8FB-24D5-CBE2-78EACAA9751B%7D.pdf
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Monetary Policy; Monetary Rules; Overlapping Generations;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • 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
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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