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Lien Laureys, Mr. Roland Meeks, and Boromeus Wanengkirtyo

some extent, because output gap stabilization and credit spread stabilization are somewhat complementary. But the relationship is imperfect. As the output gap-inflation trade-off is unfavorable, given the presence of shocks to price and wage mark-ups in the data, inflation volatility is higher under the dual mandate, and welfare is lower. In focusing on the role of welfare-optimal monetary policy in financial stabilization, we do not mean to suggest that other, perhaps more pressing considerations, should be excluded from monetary policy decisions in practice. 4

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.