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Source: International Monetary Fund

Monetary and Macroprudential Policy with Endogenous Risk

Author/Editor:

Tobias Adrian ; Fernando Duarte ; Nellie Liang ; Pawel Zabczyk

Publication Date:

November 13, 2020

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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 extend the New Keynesian (NK) model to include endogenous risk. Lower interest rates not only shift consumption intertemporally but also conditional output risk via their impact on risk-taking, giving rise to a vulnerability channel of monetary policy. The model fits the conditional output gap distribution and can account for medium-term increases in downside risks when financial conditions are loose. The policy prescriptions are very different from those in the standard NK model: monetary policy that focuses purely on inflation and output-gap stabilization can lead to instability. Macroprudential measures can mitigate the intertemporal risk-return tradeoff created by the vulnerability channel.

Series:

Working Paper No. 2020/236

Frequency:

regular

English

Publication Date:

November 13, 2020

ISBN/ISSN:

9781513561066/1018-5941

Stock No:

WPIEA2020236

Format:

Paper

Pages:

55

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