Abstract
We study optimized Taylor rules that incorporate financial stability considerations, which have been little analysed for emerging market economies. Setting the policy interest rate with a greater financial stability consideration reduces monetary policy effectiveness: a greater effort to reduce output volatility in the nontradables sector, where asset bubbles are prone to build, leads to greater inflation volatility.
Notes
1 , the target inflation rate, is set to zero without loss of generality.
2 Brazil, Chile, Czech Republic, Hungary, India, Indonesia, Israel, Malaysia, Mexico, Philippines, Poland, South Africa, Thailand and Turkey. Parameters estimated for three regions (Asia; Latin America; Eastern Europe; Middle East and Africa) separately are broadly similar. We set α11 = 0.60, α13 = 0.05, α14 = –0.10, α15 = –0.20, α21 = 0.15, α22 = 0.75, α23 = 0.10, α33 = 0.85, α35 = –0.50, α41 = 0.10, α43 = 0.10, α44 = 0.70, α45 = 0.20. The size and signs of the coefficients are mostly economically plausible; see Gadanecz et al. (Citation2014) for further details. In our estimations and subsequent simulations, all variables correspond to deviations from the equilibrium (or trend).
3 These increases are statistically insignificant, as the corresponding confidence intervals overlap.