Discussion Paper Details

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Title: Monetary and Macroprudential Policy with Endogenous Risk

Author(s): Tobias Adrian, Fernando Duarte, Nellie Liang and Pawel Zabczyk

Publication Date: February 2020

Keyword(s): Macro-Finance, macroprudential policy and monetary policy

Programme Area(s): Monetary Economics and Fluctuations

Abstract: 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 the 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.

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Bibliographic Reference

Adrian, T, Duarte, , Liang, N and Zabczyk, P. 2020. 'Monetary and Macroprudential Policy with Endogenous Risk'. London, Centre for Economic Policy Research.