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Monetary policy and financial stability in the long run

Author

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  • Jin Cao

    (Norges Bank (Central Bank of Norway), CESifo, Germany)

  • Loran Chollete

    (UiS Business School, Norway)

Abstract

Most theoretical central bank models use short horizons and focus on a single tradeoff. However, in reality, central banks play complex, long-horizon games and face more than one tradeoff. We account for these issues in a simple infinite-horizon game with a novel tradeoff: higher rates deter financial imbalances, but lower rates reduce the likelihood ofinsolvency. We term these factors discipline and stability effects, respectively. The centralbank's welfare decreases with dependence between real and financial shocks, so it may reduce costs with correlation-indexed securities. In our model, independent central banks cannot in general attain both low inflation and financial stability.

Suggested Citation

  • Jin Cao & Loran Chollete, 2013. "Monetary policy and financial stability in the long run," Working Paper 2013/21, Norges Bank.
    • Handle: RePEc:bno:worpap:2013_21
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    File URL: https://www.norges-bank.no/en/news-events/news-publications/Papers/Working-Papers/2013/WP-201321/
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    References listed on IDEAS

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    More about this item

    Keywords

    Central Bank; Correlation-indexed security; Discipline effect; Stability effect;
    All these keywords.

    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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