## The Diagnostic Financial Accelerator

_IMF Working Papers, June 28, 2024_

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## Bibliographic details
- Authors: Lahcen Bounader, Selim A Elekdag
- Published: June 28, 2024
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9798400279287.001

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### Overview and Model
- Authors: Lahcen Bounader, Selim A Elekdag
- Publication: IMF Working Papers, Working Paper No. 2024/132
- Date: June 28, 2024
- Pages: 53
- DOI: https://doi.org/10.5089/9798400279287.001
- ISBN: 9798400279287
- ISSN: 1018-5941

- The paper develops a model combining Diagnostic Expectations (DE) and a Financial Accelerator (FA).
- DE and FA generate mutually reinforcing shock amplification, with particularly strong amplification for demand shocks.
- Supply shocks can be dampened via a debt deflation channel; this channel is strengthened in the presence of DE.
- The model produces a worsening of the inflation-output volatility trade-off facing policymakers.

### Key Findings
- Diagnostic expectations amplify the financial accelerator mechanism, increasing the magnitude of macroeconomic responses to shocks.
- Demand shocks experience especially pronounced amplification due to the interaction of DE and FA.
- Supply shocks can be mitigated through a debt deflation channel; this mitigation is stronger when DE is present.
- The inflation-output volatility trade-off deteriorates in the model, implying tougher stabilization choices for policymakers.
- Contrary to much of the literature that argues against targeting the level of asset prices, this model suggests that targeting house price growth may yield welfare gains.

### Policy Implications and Recommendations
- Policymakers face a worsened inflation-output volatility trade-off when DE is active alongside FA; stabilization strategies should account for this aggravated trade-off.
- Consideration of house price growth as a policy target could produce welfare improvements in the context of the model with DE and FA.
- Monetary policy rules and instrument design should account for model dynamics where asset-price growth interacts with financial amplification and expectations.

### Subject Areas and Keywords
- Subjects: Asset prices, Business cycles, Consumption, Economic growth, Housing prices, Inflation, National accounts, Prices
- Keywords: Asset prices, Business cycles, Consumption, debt deflation channel, Diagnostic Expectations, Financial Accelerator, Global, house price growth, Housing prices, Inflation, inflation trade-off, inflation-output volatility trade-off, Instrument rules, model dynamics, Optimal monetary policy

*IMF Working Paper No. 2024/132 — "The Diagnostic Financial Accelerator", Lahcen Bounader and Selim A Elekdag, June 28, 2024.*

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_Source: https://www.imf.org/en/publications/wp/issues/2024/06/28/the-diagnostic-financial-accelerator-550963_