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Report
Monetary policy, financial conditions, and financial stability
We review a growing literature that incorporates endogenous risk premiums and risk taking in the conduct of monetary policy. Accommodative policy can create an intertemporal trade-off between improving current financial conditions and increasing future financial vulnerabilities. In the United States, structural and cyclical macroprudential tools to reduce vulnerabilities at banks are being implemented, but they may not be sufficient because activities can migrate and there are limited tools for nonbank intermediaries and for borrowers. While monetary policy itself can influence ...
Working Paper
Asset Price Learning and Optimal Monetary Policy
We characterize optimal monetary policy when agents are learning about endogenous asset prices. Boundedly rational expectations induce inefficient equilibrium asset price fluctuations which translate into inefficient aggregate demand fluctuations. We find that the optimal policy raises interest rates when expected capital gains, and the level of current asset prices, is high. The optimal policy does not eliminate deviations of asset prices from their fundamental value. When monetary policymakers are information-constrained, optimal policy can be reasonably approximated by simple interest rate ...
Report
The Nonlinear Case Against Leaning Against the Wind
We re-examine the relationship between monetary policy and financial stability in a setting that allows for nonlinear, time-varying relationships between monetary policy, financial stability, and macroeconomic outcomes. Using novel machine-learning techniques, we estimate a flexible “nonlinear VAR” for the stance of monetary policy, real activity, inflation, and financial conditions, and evaluate counterfactual evolutions of downside risk to real activity under alternative monetary policy paths. We find that a tighter path of monetary policy in 2003-05 would have increased the risk of ...