Working Paper: CEPR ID: DP12681
Authors: Tobias Adrian; Fernando Duarte; Federico Grinberg; Tommaso Mancinigriffoli
Abstract: Loose fi nancial conditions forecast high output growth and low output volatility up to six quarters into the future, generating time varying downside risk to the output gap which we measure by GDP-at-Risk (GaR). This fi nding is robust across countries, conditioning variables,and time periods. We study the implications for monetary policy in a reduced form New Keynesian model with fi nancial intermediaries that are subject to a Value at Risk (VaR) constraint. Optimal monetary policy depends on the magnitude downside risk to GDP, as it impacts theconsumption-savings decision via the Euler constraint, and the financial conditions via the tightness of the VaR constraint. The optimal monetary policy rule exhibits a pronounced response to shifts in fi nancial conditions for most countries in our sample. Welfare gains from taking financial conditions into account are shown to be sizable.
Keywords: monetary policy; financial conditions; financial stability
JEL Codes: E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial conditions (E66) | Consumption-savings decision (E21) |
| Financial conditions (E66) | Tightness of VaR constraint (C58) |
| Financial conditions (E66) | Optimal monetary policy (E63) |
| Financial conditions (E66) | Economic stability (E60) |
| Financial conditions (E66) | Output variance management (C29) |
| Deteriorating financial conditions (F65) | Conditional mean and volatility of output gap (E37) |
| Financial conditions (E66) | Output gap (E23) |
| Loose financial conditions (E44) | High output growth (O49) |
| Loose financial conditions (E44) | Low output volatility (E39) |
| Financial conditions (E66) | Downside risk to output gap (E23) |
| Financial conditions (E66) | Economic volatility (E32) |