Inês Drumond

Un)anticipated monetary policy in a DSGE model with a shadow banking system

Motivated by the U.S. events of the 2000s, we address whether a too low for too long interest rate policy may generate a boom-bust cycle. We simulate anticipated and unanticipated monetary policies in state-of-the-art DSGE models and in a model with bond financing via a shadow banking system, in which the bond spread is calibrated for normal and optimistic times. Our results suggest that the U.S. boom-bust was caused by the combination of (i) interest rates that were too low for too long, (ii) excessive optimism and (iii) a failure of agents to anticipate the extent of the abnormally favourable conditions.

Financial Shocks and Optimal Monetary Policy Rules

We assess the performance of optimal Taylor-type interest rate rules, with and without reaction to financial variables, in stabilizing the macroeconomy following financial shocks. We use a DSGE model that comprises both a loan and a bond market, which best suits the contemporary structure of the U.S. financial system and allows for a wide set of financial shocks and transmission mechanisms. Overall, we find that targeting financial stability – in particular credit growth, but in some cases also financial spreads and asset prices – improves macroeconomic stabilization. The specific policy implications depend on the policy regime, and on the origin and the persistence of the financial shock.