IMF Working Papers

Output Gap in Presence of Financial Frictions and Monetary Policy Trade-offs

By Francesco Furlanetto, Paolo Gelain, Marzie Taheri Sanjani

July 18, 2014

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Francesco Furlanetto, Paolo Gelain, and Marzie Taheri Sanjani. Output Gap in Presence of Financial Frictions and Monetary Policy Trade-offs, (USA: International Monetary Fund, 2014) accessed September 18, 2024
Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

The recent global financial crisis illustrates that financial frictions are a significant source of volatility in the economy. This paper investigates monetary policy stabilization in an environment where financial frictions are a relevant source of macroeconomic fluctuation. We derive a measure of output gap that accounts for frictions in financial market. Furthermore we illustrate that, in the presence of financial frictions, a benevolent central bank faces a substantial trade-off between nominal and real stabilization; optimal monetary policy significantly reduces fluctuations in price and wage inflations but fails to alleviate the output gap volatility. This suggests a role for macroprudential policies.

Subject: Economic theory, Financial frictions, Inflation, Labor, Output gap, Potential output, Prices, Production, Wages

Keywords: Asset price inflation, Computing output gap, Efficient frontier, Financial Frictions, Implied output gaps, Inflation, Inflation target shock, Mark-up shock, Monetary policy, Monetary policy authority, Monetary policy shock, Optimal Monetary Policy, Output Gap, Output gap dynamics, Output gap in presence, Output gap stabilization, Potential output, Wage inflation, Wages, WP

Publication Details

  • Pages:

    44

  • Volume:

    ---

  • DOI:

    ---

  • Issue:

    ---

  • Series:

    Working Paper No. 2014/128

  • Stock No:

    WPIEA2014128

  • ISBN:

    9781498305327

  • ISSN:

    1018-5941

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