Monetary Policy and Fears of Financial Instability

  title={Monetary Policy and Fears of Financial Instability},
  author={Vincent Brousseau and Carsten Detken},
Exploiting a specific sunspot equilibrium in a standard forward-looking New Keynesian model, we present an example of a possible conflict between short-term price stability and financial stability. We find a conflict because the sunspot process consists of a self-fulfilling belief linking the stability of inflation to the smoothness of the interest rate path. A policy focusing only on a fixed-horizon inflation forecast neglects the potential effects of this belief on the variance of inflation… CONTINUE READING