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The Optimal Monetary Instrument for Prudential Purposes

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  • C.A.E. Goodhard
  • P. Sunirand
  • D.P. Tsomocos

Abstract

The purpose of this paper is to assess the choice between adopting a monetary base or an interest rate setting instrument to maintain financial stability. Our results suggest that the interest rate instrument is preferable, since during times of a panic or financial crisis the Central Bank automatically satisfies the increased demand for money. Thus, it prevents sharp losses in asset values and enhanced asset volatility

Suggested Citation

  • C.A.E. Goodhard & P. Sunirand & D.P. Tsomocos, 2008. "The Optimal Monetary Instrument for Prudential Purposes," Economics Series Working Papers 2008fe26, University of Oxford, Department of Economics.
    • Handle: RePEc:oxf:wpaper:2008fe26
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    References listed on IDEAS

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    1. Oriol Aspachs & Charles Goodhart & Dimitrios Tsomocos & Lea Zicchino, 2007. "Towards a measure of financial fragility," Annals of Finance, Springer, vol. 3(1), pages 37-74, January.
    2. Charles Goodhart & Pojanart Sunirand & Dimitrios Tsomocos, 2006. "A model to analyse financial fragility," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 27(1), pages 107-142, January.
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    5. Miron, Jeffrey A, 1986. "Financial Panics, the Seasonality of the Nominal Interest Rate, and theFounding of the Fed," American Economic Review, American Economic Association, vol. 76(1), pages 125-140, March.
    6. M. Shubik & D. Tsomocos, 1992. "A strategic market game with a mutual bank with fractional reserves and redemption in gold," Journal of Economics, Springer, vol. 55(2), pages 123-150, June.
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    8. William Poole, 1969. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Special Studies Papers 2, Board of Governors of the Federal Reserve System (U.S.).
    9. Charles Goodhart & Pojanart Sunirand & Dimitrios Tsomocos, 2006. "A Time Series Analysis of Financial Fragility in the UK Banking System," Annals of Finance, Springer, vol. 2(1), pages 1-21, January.
    10. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 24(Win), pages 14-23.
    11. Dimitrios P. Tsomocos, 2012. "Equilibrium Analysis, Banking and Financial Instability," Chapters, in: The Challenge of Financial Stability, chapter 4, pages 61-97, Edward Elgar Publishing.
    12. Sudipto Bhattacharya & Pojanart Sunirand, 2012. "Banks, Relative Performance, and Sequential Contagion," Chapters, in: The Challenge of Financial Stability, chapter 7, pages 153-170, Edward Elgar Publishing.
    13. Goodhart, Charles A. E. & Sunirand, Pojanart & Tsomocos, Dimitrios P., 2004. "A model to analyse financial fragility: applications," Journal of Financial Stability, Elsevier, vol. 1(1), pages 1-30, September.
    14. Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-254, April.
    15. William Poole, 1970. "Optimal Choice of Monetary Policy Instruments in a Simple Stochastic Macro Model," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 84(2), pages 197-216.
    16. Lea Zicchino & Dimitrios Tsomocos & Miguel Segoviano & Charles Goodhart & Oriol Aspachs Bracon, 2006. "Searching for a Metric for Financial Stability," FMG Special Papers sp167, Financial Markets Group.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Meixing Dai, 2010. "Financial volatility and optimal instrument choice: A revisit to Poole's analysis," Economics Bulletin, AccessEcon, vol. 30(1), pages 605-613.
    2. Marcin Wolski, 2015. "Modern Monetary Rules: Any Role for Financial Targeting?☆," International Symposia in Economic Theory and Econometrics, in: Monetary Policy in the Context of the Financial Crisis: New Challenges and Lessons, volume 24, pages 367-403, Emerald Group Publishing Limited.
    3. Maria Kasselaki & Athanasios Tagkalakis, 2014. "Financial soundness indicators and financial crisis episodes," Annals of Finance, Springer, vol. 10(4), pages 623-669, November.
    4. C. A. E. Goodhart, 2009. "The Continuing Muddles of Monetary Theory: A Steadfast Refusal to Face Facts," Economica, London School of Economics and Political Science, vol. 76(s1), pages 821-830, October.
    5. firano, zakaria & Benbachir, Saad & Abouch, Mohammed, 2012. "Macroeconomic framework for financial stability for Morocco," MPRA Paper 43998, University Library of Munich, Germany.
    6. Stan du Plessis, 2012. "Assets matter: New and old views of monetary policy," Working Papers 16/2012, Stellenbosch University, Department of Economics.
    7. repec:ebl:ecbull:v:30:y:2010:i:1:p:605-613 is not listed on IDEAS
    8. Constantine, Collin & Direye, Eli & Khemraj, Tarron, 2019. "Central Bank Bills and the Exchange Rate: The Case of Papua New Guinea," MPRA Paper 101264, University Library of Munich, Germany.
    9. Conrad F. J. Beyers & Allan Freitas & Kojo A. Essel-Mensah & Reyno Seymore & Dimitrios P. Tsomocos, 2020. "A computable general equilibrium model for banking sector risk assessment in South Africa," Annals of Finance, Springer, vol. 16(2), pages 195-218, June.
    10. Marcelo de C. Griebeler & Ronald Otto Hillbrecht, 2014. "Convexity of the central bank's loss function and dependence between monetary instruments," Economics Bulletin, AccessEcon, vol. 34(4), pages 2275-2291.
    11. Vasile Cocris & Anca Elena Nucu, 2013. "Monetary policy and financial stability: empirical evidence from Central and Eastern European countries," Baltic Journal of Economics, Baltic International Centre for Economic Policy Studies, vol. 13(1), pages 75-98, July.
    12. Kim, Jinyong & Kim, Yong-Cheol, 2013. "Financial crisis and a transmission mechanism of external shocks: The signaling role of the Korean Monetary Stabilization Bond," Journal of Financial Stability, Elsevier, vol. 9(4), pages 682-694.
    13. Tsvetomira Tsenova, 2014. "International monetary transmission with bank heterogeneity and default risk," Annals of Finance, Springer, vol. 10(2), pages 217-241, May.
    14. Charles A. E. Goodhart & Carolina Osorio & Dimitrios P. Tsomocos, 2009. "Analysis of Monetary Policy and Financial Stability: A New Paradigm," CESifo Working Paper Series 2885, CESifo.

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    More about this item

    Keywords

    Interest Rates; Monetary Base; Bank Capital; Financial Stability; Monetary Policy;
    All these keywords.

    JEL classification:

    • D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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