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Monetary Policy Tradeoffs Between Financial Stability and Price Stability

Author

Listed:
  • Shukayev, Malik

    (University of Alberta, Department of Economics)

  • Ueberfeldt, Alexander

    (Bank of Canada)

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

  • Shukayev, Malik & Ueberfeldt, Alexander, 2016. "Monetary Policy Tradeoffs Between Financial Stability and Price Stability," Working Papers 2016-18, University of Alberta, Department of Economics.
    • Handle: RePEc:ris:albaec:2016_018
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    References listed on IDEAS

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    Cited by:

    1. Fouejieu, Armand & Popescu, Alexandra & Villieu, Patrick, 2019. "Trade-offs between macroeconomic and financial stability objectives," Economic Modelling, Elsevier, vol. 81(C), pages 621-639.
    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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    More about this item

    Keywords

    Fire sales externality; short-term bank funding; business cycles; financial crisis;
    All these keywords.

    JEL classification:

    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises

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