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Financial stability and monetary policy: a reduced-form model for the Euro area

Domenii publicaţii > Economie + Tipuri publicaţii > Articol în revistã ştiinţificã

Autori: Claudiu Tiberiu Albulescu

Editorial: Romanian Journal of Economic Forecasting, 15(1), p.62-81, 2013.


This paper is related to the growing academic literature on monetary policy and
financial stability. In the first part, we propose a review of the literature on the subject,
describing both theoretical and empirical models. In the second part, based on
Filardo’s approach, we construct a reduced-form model for the Euro Area, addressing
the need to include the financial stability objective into the ECB monetary policy
decisions. The purpose of the paper is to see whether the ECB decisions can be
improved if policymakers systematically react to financial instability signals. The
novelty of the paper is the introduction of an aggregate financial instability index in the
augmented Taylor’s rule that is a part of the proposed model. Our results show that,
since the ECB setup until nowadays, the monetary policy decisions were influenced by
the financial instability level, as indicated by the optimal policy rate. However, at the
beginning and at the end of the analysed interval, we observe a discrepancy between
the real key rate and the proposed optimal policy rule. More precisely, for the period
1999-2001, the model shows that the optimal rate ranged bellow the key rate, fact
which shows that the ECB has intentionally fixed its initial interest rate to a much
higher level in order to strengthen its credibility. In the same line, in 2009 the ECB
should have decreased the key rate below the level of 1% to better overcome the lack
of liquidity on the market. Our results also show that, towards the end of the analysed
period (2010-2011), the ECB should have considerably increased the key rate to
respond to inflation threats.

Cuvinte cheie: financial stability, monetary policy, ECB, reduced-form models, Taylor rule