Monetary Policy When the Central Bank Shapes Financial-Market Sentiment
Recent research has found that monetary policy works in part by influencing the risk premiums on both traded financial-market securities and intermediated loans. Research has also shown that when risk premiums are compressed, there is an increased likelihood of a reversal that damages the credit-supply mechanism and the real economy. Together these effects create an intertemporal tradeoff for monetary policy, as stimulating the economy today can sow the seeds of a future downturn that might be difficult to offset. We introduce a simple model of this tradeoff and draw out its implications for the conduct of monetary policy.
Published Versions
Anil K Kashyap & Jeremy C. Stein, 2023. "Monetary Policy When the Central Bank Shapes Financial-Market Sentiment," Journal of Economic Perspectives, vol 37(1), pages 53-75.
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