Output Gap in Presence of Financial Frictions and Monetary Policy Trade-offs
Electronic Access:
Free Download. Use the free Adobe Acrobat Reader to view this PDF file
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.
Series:
Working Paper No. 2014/128
Subject:
Economic theory Financial frictions Inflation Labor Output gap Potential output Prices Production Wages
English
Publication Date:
July 18, 2014
ISBN/ISSN:
9781498305327/1018-5941
Stock No:
WPIEA2014128
Pages:
44
Please address any questions about this title to publications@imf.org