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Monetary policy and financial stability in the long run : a simple game-theoretic approach

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Chollete_2016_JFS_MonetaryPolicy_AAM.pdf (462.8Kb)
Date
02/2017
Author
Cao, Jin
Chollete, Lorán
Keywords
Central banking
Correlation-indexed security
Discipline effect
Stability effect
Strategic interaction
HB Economic Theory
HG Finance
NDAS
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Abstract
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.
Citation
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 . https://doi.org/10.1016/j.jfs.2016.12.002
Publication
Journal of Financial Stability
Status
Peer reviewed
DOI
https://doi.org/10.1016/j.jfs.2016.12.002
ISSN
1572-3089
Type
Journal article
Rights
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
Description
Chollete acknowledges support from Finansmarkedsfondet, of the Research Council of Norway.
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  • University of St Andrews Research
URI
http://hdl.handle.net/10023/14137

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