## Taylor Rule Under Financial Instability

_IMF Working Papers, January 1, 2008_

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## Bibliographic details
- Authors: Martin Cihak, Sofía Bauducco
- Published: January 1, 2008
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451868807.001

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### Overview and research question
- Authors: Martin Cihak, Sofía Bauducco
- Date: January 1, 2008
- Series: Working Paper No. 2008/018
- Issue: 018; Volume: 2008; Pages: 41
- DOI: https://doi.org/10.5089/9781451868807.001
- Subjects: Banking, Central bank policy rate, Financial sector, Loans, Technology
- Keywords: financial system, goods firm, monetary policy, output gap, WP

### Model extension and methodology
- Extends the standard new Keynesian dynamic stochastic general equilibrium (DSGE) model with sticky prices to include a financial system.
- Simulations are used to assess monetary-policy responses under financial instability.
- Key informational assumption: the central bank may have privileged information about credit risk.

### Main findings
- If financial instability affects output and inflation with a lag, and the central bank has privileged information about credit risk, then:
  - Monetary policy that responds instantly to increased credit risk can trade off more output and inflation instability today for a faster return to the trend than a policy that follows the simple Taylor rule with only the contemporaneous output gap and inflation.
- The paper's simulations indicate that incorporating credit-risk information into policy responses can improve the speed of recovery to trend relative to a contemporaneous-output-gap-and-inflation-only Taylor rule.

### Policy implications and recommendations
- Monetary-policy rules that incorporate indicators of financial stress or credit risk (including timely or privileged measures) can be preferable to simple Taylor-type rules that condition only on contemporaneous output gap and inflation when financial instability is present.
- Accepting higher short-run output and inflation variability may be warranted if it delivers a faster return to trend output and inflation in the presence of financial shocks that operate with lags.

### Publication and access
- Stock No: WPIEA2008018
- ISBN: 9781451868807
- ISSN: 1018-5941

*Source: Taylor Rule Under Financial Instability, IMF Working Papers (Working Paper No. 2008/018).*

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/taylor-rule-under-financial-instability-21614_