Monetary policy and fears of financial instability

Arbeitspapier

Exploiting a specific sunspot equilibrium in a standard forward-looking New Keynesian model, we present an example of a possible conflict between short-term price stability and financial stability. We find a conflict because the sunspot process consists of a self-fulfilling belief linking the stability of inflation to the smoothness of the interest rate path. A policy focusing only on a fixed-horizon inflation forecast neglects the potential effects of this belief on the variance of inflation. The nature of the conflict case is interpreted as evidence for the occasional relevance as well as the general tenuousness of the conflict case. The implementation of our example has led us, furthermore, to illustrate the lack of general applicability of the Bellman principle in dynamic programming for forward-looking models. Our result holds with respect to a more general (Nash-type) concept of optimality

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: ECB Working Paper ; No. 89

Classification and Topics

• Classification: Wirtschaft ; Optimization Techniques; Programming Models; Dynamic Analysis ; Existence and Stability Conditions of Equilibrium ; Monetary Policy ; Central Banks and Their Policies

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Brousseau, Vincent ; Detken, Carsten
• Event: Veröffentlichung
• (who): European Central Bank (ECB)
• (where): Frankfurt a. M.
• (when): 2001

Further information

• Handle: http://hdl.handle.net/10419/152523
• Last update: 10.03.2025, 11:43 AM CET