Monetary Policy Rules and Financial Stability
NBER Working Paper No. 4692 (Also Reprint No. r2042)
This paper investigates empirically the possibility that a central bank could adhere to a macro-oriented monetary policy rule while also providing lender-of-last-resort services to the financial system. The method considered involves smoothing week-to-week movements of an interest rate instrument so as to achieve quarterly- average intermediate targets for the monetary base, with these specified so as to keep aggregate nominal spending growing steadily at a noninflationary rate. Simulations utilizing weekly U.S. data are conducted with a system consisting of a policy rule for the federal funds rate--one designed to hit monetary base targets obtained from a quarterly macroeconomic rule--and an empirically-based model of the response of base growth to funds rate movements. Results for the periods 1974-1979 (Sept.) and 1988-1991 suggest that such a procedure could succeed in reconciling macroeconomic goals with the provision of lender-of-last-resort services.
Published: Financial Stability in a Changing Environment, Kuniho Sawamoto, Zeuta Makajima and Hiroo Taguchi, eds., pp. 389-421, (New York: St. Martin's Press, 1995).