Optimal monetary policy rules,financial amplification,and uncertain business cycles |
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| Institution: | 1. EPFL, College of Management, Switzerland;2. European Central Bank, Directorate General Research, Monetary Policy Research, Germany;3. Vienna University of Economics and Business, Austria;1. Department of Surgery, Section of Vascular Surgery and Endovascular Therapy, Instituto Nacional de Ciencias Médicas y Nutricion Salvador Zubiran, Mexico;2. Department of Pathology, Instituto Nacional de Pediatria, Mexico;1. Research Department, Federal Reserve Bank of Dallas, 2200 N Pearl Street, Dallas, TX 75201, United States of America;2. Department of Economics, William & Mary, P.O. Box 8795, Williamsburg, VA 23187, United States of America |
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| Abstract: | This paper studies optimal monetary policy in the presence of ‘uncertainty’, time-variation in cross-sectional dispersion of firms׳ productive performance. Using a model with financial market imperfections, the results suggest that (i) optimal policy is to dampen the strength of financial amplification by responding to uncertainty (at the expense of creating mild degree of fluctuations in inflation). (ii) Higher uncertainty makes the welfare-maximizing planner more willing to relax financial constraints. (iii) Credit spreads are a good proxy for uncertainty. Hence, a non-negligible response to credit spreads – together with a strong anti-inflationary policy stance – achieves the highest aggregate welfare possible. |
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| Keywords: | Optimal monetary policy Financial amplification Uncertainty shocks |
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