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Optimal monetary policy with uncertainty about financial frictions

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  • Moessner, Richhild

Abstract

This paper studies optimal discretionary monetary policy in the presence of uncertainty about the degree of financial frictions. Changes in the degree of financial frictions are modelled as changes in parameters of a hybrid New-Keynesian model calibrated for the UK, following Bean, Larsen and Nikolov (2002). Uncertainty about the degree of financial frictions is modelled as Markov switching between regimes without and with strong financial frictions. Optimal monetary policy is determined for different scenarios of permanent and temporary regime shifts in financial frictions, as well as for variations in financial frictions over the business cycle. Optimal monetary policy is found to be state-dependent. In each state, optimal monetary policy depends on the transition probabilities between the different regimes. JEL Classification: E52, E58, E61, E44

Suggested Citation

  • Moessner, Richhild, 2006. "Optimal monetary policy with uncertainty about financial frictions," Working Paper Series 639, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:2006639
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    File URL: https://www.ecb.europa.eu//pub/pdf/scpwps/ecbwp639.pdf
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    References listed on IDEAS

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    4. Richhild Moessner, 2006. "Optimal discretionary policy in rational expectations models with regime switching," Bank of England working papers 299, Bank of England.
    5. Bean, Charles & Larsen, Jens D. J. & Nikolov, Kalin, 2002. "Financial frictions and the monetary transmission mechanism: theory, evidence and policy implications," Working Paper Series 113, European Central Bank.
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    Cited by:

    1. J. Scott Davis & Kevin X. D. Huang, 2011. "Optimal monetary policy under financial sector risk," Globalization Institute Working Papers 85, Federal Reserve Bank of Dallas.
    2. Francesco Furlanetto & Paolo Gelain & Marzie Taheri Sanjani, 2014. "Output Gap in Presence of Financial Frictions and Monetary Policy Trade-offs," IMF Working Papers 2014/128, International Monetary Fund.

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    More about this item

    Keywords

    financial frictions.; monetary policy; uncertainty;
    All these keywords.

    JEL classification:

    • 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
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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