Monetary policy and financial stability in the long run : a simple game-theoretic approach
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Many theoretical central bank models use short horizons and focus on a single tradeoff. However, in reality, central banks play complex, long-horizon games and face more than one tradeoff. We account for these strategic interactions in a simple infinite-horizon game with a novel tradeoff: tighter monetary policy deters financial imbalances, but looser monetary policy reduces the likelihood of insolvency. We term these factors discipline and stability effects, respectively. The central bank’s welfare decreases with dependence between real and financial shocks, so it may reduce costs with correlation-indexed securities. An independent central bank cannot in general attain both low inflation and financial stability.
Cao , J & Chollete , L 2017 , ' Monetary policy and financial stability in the long run : a simple game-theoretic approach ' Journal of Financial Stability , vol 28 , pp. 125-142 . DOI: 10.1016/j.jfs.2016.12.002
Journal of Financial Stability
Copyright © 2016, Elsevier B.V. This work is made available online in accordance with the publisher’s policies. This is the author created, accepted version manuscript following peer review and may differ slightly from the final published version. The final published version of this work is available at https://doi.org/10.1016/j.jfs.2016.12.002
DescriptionChollete acknowledges support from Finansmarkedsfondet, of the Research Council of Norway.
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