The Taylor Rule and Financial Stability. A Literature Review with Application for the Eurozone
Benjamin Käfer, University of Kassel, 2014-06-10
The question whether central banks should bear responsibility for financial stability
remains unanswered. In connection with the use of interest rates, it is therefore not
clear whether and how the Taylor rule should be augmented by an additional financial
stability term. This paper reviews the normative and positive literature on Taylor rules
augmented with exchange rates, asset prices, credit, and spreads. These measures
have evolved as common indicators of financial (in)stability in the Taylor rule literature.
In addition, our own analysis describes the development of these indicators for
the core and the periphery of the Eurozone. Given the high degree of heterogeneity
between euro area countries, the conclusion here is that an interest rate reaction to
instability by the European Central Bank would be inappropriate in times of crisis.
However, this conclusion is somewhat weakened if there is no crisis.
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| year: | 2014 |
| volume: | 65, Issue 2 |
| pages: | 159-192 |
| JEL: | E52, F33, F42 |
| keywords: | asset_prices credit_spreads eurozone_heterogeneity exchange_rates financial_stability sovereign_debt_crisis taylor_rule |
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