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Mr. Tobias Adrian, Fernando Duarte, Nellie Liang, and Pawel Zabczyk

equal their respective steady state of zero. Accordingly, in such circumstances, the process for financial conditions η t would approximately reduce to η t + λ η η t − 1 + λ η η η t − 2 . This shows that under full output gap stabilization, η t would only depend on its own lags. It follows that if we initialized the system in its steady state, then financial conditions would stay in that steady state forever. As a consequence, vulnerability would also be

Mr. Tobias Adrian, Fernando Duarte, Nellie Liang, and Pawel Zabczyk
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.
Mr. Nooman Rebei and Mr. Mohamed Safouane Ben Aissa
This paper investigates optimized monetary policy rules in the presence of government intervention to stabilize prices of certain categories of goods and services. The paper estimates a small-scale, structural equilibrium model with a sticky-price sector and a subsidized price sector for a large number of countries using Bayesian methods. The main result of this paper is that strict headline inflation targeting could be outperformed by sectoral inflation targeting, output gap stabilization, or a combination of these. In addition, several country cases exhibit lower performance of both headline and core inflation stabilization, the two most common policies in modern central banks' practices. For practical monetary policy design, we numerically identify country specific thresholds for the degree of government intervention in price setting under which core inflation targeting turns out to be the optimal choice in the context of implementable Taylor rules.
Mr. Nooman Rebei and Mr. Mohamed Safouane Ben Aissa

’s welfare as a metric. Results show that strict headline inflation targeting could be easily dominated by sectoral inflation targeting, output gap stabilization, or a combination of these. The appropriate monetary policy to adopt in the presence of subsidized prices and costly adjusting of prices is sensitive to the relative importance of the two distortions. Also, the way governments finance subsidies is crucial for designing the optimized monetary rule. Interestingly, we find cases where price subsidies are relatively more distorting than nominal price inertia in the

Lien Laureys, Mr. Roland Meeks, and Boromeus Wanengkirtyo

Figure 2. The monetary policy frontier under a dual mandate Figure 3. The volatility of welfare-relevant variables under a dual mandate Figure 4. Welfare losses under extended mandates Figure 5. Policy frontiers for the financial stabilization objective Figure 6. Policy frontiers for the output gap stabilization objective Figure 7. Dual mandate with alternative resource utilization measures Figure 8. The role of mark-up shocks Figure 9. Volatility as a function of the weight on interest rate smoothing Tables Table 1. Data series, data transformations

Davide Debortoli, Mr. Jinill Kim, Jesper Lindé, and Mr. Ricardo C Nunes

in a standard inflation-output gap loss function in a framework with both wage and price stickiness. However, the analysis with the canonical model demonstrates that the merits of a dual mandate depend on the structure of the economy (distortions in goods and labor markets) as well as shocks creating a trade-off between inflation and output gap stabilization. We therefore complement this analysis with numerical simulations in an estimated medium-scale model. Specifically, we use the workhorse Smets and Wouters (2007) empirical model—SW henceforth—of the U

Lien Laureys, Mr. Roland Meeks, and Boromeus Wanengkirtyo

on euro area data. 3 Our main finding is that assigning a financial stabilization objective to monetary policy, alongside its traditional remit for inflation and output gap stabilization, yields welfare benefits comparable to those of the Ramsey policy. A ternary financial stabilization objective is therefore highly desirable, as it delivers welfare outcomes that are close to the best achievable, but with a remit that is easily codified and communicated. The key insight that our exercise provides is that financial frictions are welfare-relevant, but at the same

Lien Laureys, Mr. Roland Meeks, and Boromeus Wanengkirtyo
We reconsider the design of welfare-optimal monetary policy when financing frictions impair the supply of bank credit, and when the objectives set for monetary policy must be simple enough to be implementable and allow for effective accountability. We show that a flexible inflation targeting approach that places weight on stabilizing inflation, a measure of resource utilization, and a financial variable produces welfare benefits that are almost indistinguishable from fully-optimal Ramsey policy. The macro-financial trade-off in our estimated model of the euro area turns out to be modest, implying that the effects of financial frictions can be ameliorated at little cost in terms of inflation. A range of different financial objectives and policy preferences lead to similar conclusions.
Nir Klein
This paper applies a state-space approach to estimate the implicit inflation target of the South African Reserve Bank (SARB) since the adoption of the Inflation Targeting (IT) framework. The paper's findings are two. First, although the official inflation target range is 3.6 percent, in practice, the SARB seems to have aimed for the upper segment of the band (41.2 .6 percent) for most of the period, despite the substantial variation of the output gap. Second, the estimation results show that the implicit inflation target varied over time, and in recent years it has shifted toward the upper limit of the inflation target range. This perhaps suggests that since the outbreak of the financial crisis in 2008, the SARB's tolerance for higher inflation has somewhat increased to better support economic activity.
Francesco Furlanetto, Paolo Gelain, and Marzie Taheri Sanjani
The recent global financial crisis illustrates that financial frictions are a significant source of volatility in the economy. This paper investigates monetary policy stabilization in an environment where financial frictions are a relevant source of macroeconomic fluctuation. We derive