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Should monetary policy pay attention to financial stability? A DSGE approach
Název práce v češtině: Má měnová politika věnovat pozornost finanční stabilitě? Pohled s využitím DSGE modelů
Název v anglickém jazyce: Should monetary policy pay attention to financial stability? A DSGE approach
Klíčová slova anglicky: monetary policy, inflation targeting, financial stability, DSGE models, financial imperfections
Akademický rok vypsání: 2014/2015
Typ práce: diplomová práce
Jazyk práce: angličtina
Ústav: Institut ekonomických studií (23-IES)
Vedoucí / školitel: doc. Mgr. Tomáš Holub, Ph.D.
Řešitel: skrytý - zadáno vedoucím/školitelem
Datum přihlášení: 19.06.2015
Datum zadání: 19.06.2015
Datum a čas obhajoby: 23.06.2016 11:30
Místo konání obhajoby: IES
Datum odevzdání elektronické podoby:12.05.2016
Datum proběhlé obhajoby: 23.06.2016
Oponenti: PhDr. Diana Žigraiová, Ph.D.
Kontrola URKUND:
Zásady pro vypracování
Standard monetary policy arrangements usually assume only one or at most two goals of central banks’ monetary policy – these are inflation and output. The other aspects of an economy, such as financial sector developments, are not directly incorporated into monetary policy rules. In this view, they are suppressed and no attention is paid to the evolution of the financial sector and its implications for monetary policy decisions.

However, the recent financial crisis starting in 2007 has brought new insights into the financial stability and its role in monetary policy. The roots of the crisis can be found in the U.S. financial sector. Even though that financial sector gave obvious signals about potential harmful development, the Fed did not pay attention to them and did not alter its policy rate accordingly. Therefore, the recent literature has started the discussion about the financial stability as an important, inseparable and direct part of the central banks’ decision making rule. Two strands of opinions have emerged. The first strand defends the new approach stating that some kind of a financial stability indicator should be directly incorporated into the monetary policy rule. Such augmented rule takes into account the financial sector and its role in inflation development, and the rule then leads to more favorable long-term results. The future path of inflation is adjusted accordingly and makes economies more stable. On the other hand, the opposing strand argues that direct incorporation of the financial stability indicator into the rule is not optimal because the central bank’s role based on a stable inflation level is harmed. It is because a certain weight is put on financial stability and it is not possible to pursue two completely different goals of monetary policy (i.e. inflation and financial stability) by using only one monetary policy tool. Therefore, the proponents of this view say that it would be optimal to propose a new additional tool and separate these two goals into two different parts. Since this discussion is not clear cut, a lot of space is left for further investigation.

Hypothesis #1: A central bank pursuing inflation targeting regime achieves better performance under a policy rule which takes into account not only developments in inflation, but also a financial stability indicator compared to the pure inflation targeting rule.

Hypothesis #2: A pre-emptive reaction of monetary policy taking into account a financial stability indicator reduces creation of possible future financial imbalances.
Seznam odborné literatury
Adrian, T., Liang, N. (2014): "Monetary Policy, Financial Conditions, and Financial Stability." Federal Reserve Bank of New York Staff Reports, no. 690.

Agénor, P.R., Pereira da Silva, L. (2013): "Inflation Targeting and Financial Stability." Inter-American Development Bank, Washington DC.

Andrle, M., Hlédik, T., Kameník, O.,Vlček, J. (2009): "Implementing the New Structural Model of the Czech National Bank." CNB Working Paper Series, no. 2/2009.

Brázdik, F., Hlaváček, M., Maršál, A. (2011): "Survey of Research on Financial Sector Modeling within DSGE Models: What Central Banks Learn from It". CNB Research and Policy Notes, no. 3/2011.

Cecchetti, S.B., Genberg, H., Lipsky, J., Wadhwani, S. (2000): "Asset Prices and Central Bank Policy." London: International Centre for Monetary and Banking Studies.

Cúrdia, V., Ferrero, A., Ng, G.C., Tambalotti, A. (2011): "Evaluating Interest Rate Rules in an Estimated DSGE Model." Federal Reserve Bank of New York Staff Reports, no. 510.

Galí, J. (2008): "Monetary policy, inflation, and the business cycle: an introduction to the new Keynesian framework." Princeton University Press.

Gambacorta, L., Signoretti, F.M. (2014): "Should monetary policy lean against the wind?
An analysis based on a DSGE model with banking." Journal of Economic Dynamics & Control 43: pp.146–174.

International Monetary Fund (IMF) (2009): "Lessons for Monetary Policy from Asset Price Fluctuations." Chapter 3 in World Economic Outlook (October). Washington, DC: International Monetary Fund.

Käfer, B. (2014): "The Taylor Rule and Financial Stability: A Literature Review with Application for the Eurozone." Review of Economics, no.65: pp. 159-192.

Woodford, M. (2012): "Inflation Targeting and Financial Stability." NBER Working Paper, no. 17967. Cambridge, MA: National Bureau of Economic Research.
Předběžná náplň práce v anglickém jazyce
Since the connection between monetary policy and a financial stability is a current topic, there are many issues not covered sufficiently by the contemporary literature. The thesis will broaden the discussion by introducing a small open economy DSGE model. Therefore, its results will contribute to the discussion concerning small open economies. Moreover, the author plans to calibrate the model for the Czech Republic. Even though the Czech National Bank has incorporated financial stability as its goal a few years ago, the discussion about modelling monetary policy and a financial stability within a DSGE framework is not so broad in the Czech Republic. Thus, the results of the thesis will contribute to and could stir up the discussion, and could be used for a further investigation of the relation between monetary policy and financial stability concerning the Czech Republic.

In the thesis, the author will compare and investigate the effectiveness and the implications of monetary policy rules considering financial stability indicator in the inflation targeting regime. The thesis will consist of three main sections. In the first section, the recent literature regarding financial stability and its connection to monetary policy will be discussed and approaches to modelling of various financial stability indicators within a DSGE framework will be introduced. The second section will be devoted mainly to the construction of a small open economy DSGE model with financial frictions. The plan is to construct a benchmark small open economy DSGE model capturing a central bank pursuing inflation targeting regime. In such situation, the role of a central bank is to keep inflation on the pre-defined inflation target level within a certain band. Therefore, a major weight is put on inflation and other aspects, such as financial stability, are suppressed. Since the aim is to broaden the discussion in the Czech Republic, the author will use a simplified version of the reaction function used by the Czech National Bank. Lastly, a financial stability condition will be implemented into the model. Thus, the role of the central bank is slightly altered and a certain weight is put on the financial stability as well. The results of such altered model will be then compared to the baseline version which does not consider the financial stability as a secondary goal of monetary policy. The comparison, the effectiveness and the implications of these different arrangements will be described by using impulse response functions depicting reactions of an economy to various shocks. The model will be calibrated for the Czech Republic. In the last section, a thorough discussion of the results and policy implications will be provided.

1. Introduction
2. Financial stability and financial stability indicators
3. Modelling financial aspects of monetary policy
3.1. Approaches to modelling financial frictions within DSGE
3.2. Incorporating financial stability indicator into monetary policy reaction function
4. A small open economy New Keynesian DSGE model with financial frictions
5. Calibration for the Czech Republic
6. Comparison of monetary policy rules
7. Policy implications
8. Conclusions
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