Monetary and Macroprudential Policy with Endogenous Risk
Author:
Mr. Tobias Adrian
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https://orcid.org/0000-0001-9379-9592
,
Fernando Duarte
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Nellie Liang null

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Pawel Zabczyk null

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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 their 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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IMF Working Papers