Optimal Simple Objectives for Monetary Policy when Banks Matter

By Lien Laureys, Roland Meeks, Boromeus Wanengkirtyo

November 13, 2020

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Format: Chicago

Lien Laureys, Roland Meeks, and Boromeus Wanengkirtyo. Optimal Simple Objectives for Monetary Policy when Banks Matter, (USA: International Monetary Fund, 2020) accessed November 8, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

We reconsider the design of welfare-optimal monetary policy when financing frictions impair the supply of bank credit, and when the objectives set for monetary policy must be simple enough to be implementable and allow for effective accountability. We show that a flexible inflation targeting approach that places weight on stabilizing inflation, a measure of resource utilization, and a financial variable produces welfare benefits that are almost indistinguishable from fully-optimal Ramsey policy. The macro-financial trade-off in our estimated model of the euro area turns out to be modest, implying that the effects of financial frictions can be ameliorated at little cost in terms of inflation. A range of different financial objectives and policy preferences lead to similar conclusions.

Subject: Economic theory, Financial frictions, Inflation, Inflation targeting, Monetary policy, Output gap, Prices, Production, Production growth

Keywords: Banks, Euro area economy, Euro area economy., Financial frictions, Inflation, Inflation targeting, Inflation-output gap trade-off, Medium-scale DSGE models, Monetary policy, Output gap, Output gap stabilization, Output gap volatility, Output gap-inflation trade-off, Production growth, Simple loss function, Stabilization objective, WP

Publication Details

Pages:

59
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2020/244
Stock No:

WPIEA2020244
ISBN:

9781513561172
ISSN:

1018-5941

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