Optimal Simple Objectives for Monetary Policy when Banks Matter

Author/Editor:

Lien Laureys ; Roland Meeks ; Boromeus Wanengkirtyo

Publication Date:

November 13, 2020

Electronic Access:

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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.

Series:

Working Paper No. 2020/244

Frequency:

regular

English

Publication Date:

November 13, 2020

ISBN/ISSN:

9781513561172/1018-5941

Stock No:

WPIEA2020244

Format:

Paper

Pages:

59

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