We study the conditions that ensure rational expectations equilibrium (REE) determinacy and expectational stability (E-stability) in a standard sticky-price model augmented with the cost channel. We allow for varying degrees of pass-through of the policy rate to bank-lending rates. Strong cost-side effects limit the size of the policy rate response to inflation that is consistent with determinacy, so that inflation-targeting policies may not be capable of ensuring REE uniqueness. In this case it is advisable to combine policy rate responses to inflation with an appropriate reaction to the output gap and/or firm profitability. The negative reaction of real activity and asset prices to inflationary shocks adds a negative force to inflation responses that counteracts the borrowing cost effect and prevents expectations of higher inflation from becoming self-fulfilling.

This paper applies a factor-augmented vector autoregressive model to U.S. data with the aim of analyzing monetary transmission via private sector balance sheets, credit risk spreads, and house prices and of exploring the role of monetary policy in the housing and credit boom prior to the global financial crisis. We find that monetary policy shocks have a persistent effect on house prices, real estate wealth, and private sector debt and a strong short-lived effect on risk spreads in money and mortgage markets. Moreover, the results suggest that monetary policy contributed considerably to the unsustainable precrisis developments in housing and credit markets. Although monetary policy shocks contributed discernibly at a late stage of the boom, feedback effects of other (macroeconomic and financial) shocks via lower policy rates kicked in earlier and appear to have been considerable.

Using a macroeconomic model with asset prices, we analyze how optimal monetary policy and macroeconomic dynamics and performance are affected by a central bank's desire to be robust against model misspecifications. We show that a higher central bank preference for robustness implies a more aggressive reaction of the nominal interest rate to the expected future inflation rate and inflation shocks. The dynamic stability of the equilibrium is not modified for a sufficiently high preference for robustness. However, the speed of dynamic convergence is lower under robust control compared to a benchmark case without it and implies supplementary economic costs. Finally, an increase in the preference for robustness comes at the cost of higher macroeconomic and financial volatility in the presence of inflation shocks. It has no effect on the reaction of inflation, output gap, and asset price gap to shocks affecting goods and financial markets.

The present paper uses an analytical approach to derive approximate closed-form solutions for the asset moments of a real-business-cycle model with idiosyncratic risk. To preserve analytical tractability, risk sharing is completely shut down. Further, the firm is assumed to maximize a variant of value maximization, given that its usual objective is no longer well defined under market incompleteness. When idiosyncratic risk is incorporated into the model, the asset moments can be decomposed into their value under identical households plus a new idiosyncratic term. Under full constrained persistence, in which case the same household determines the asset moments every period, the model is able to generate the risk premium in the data with reasonable parameter values, but it cannot generate the risk return trade-off. While the quantitative impact of idiosyncratic risk is smaller when there is only some persistence in who is constrained, the qualitative predictions are unaltered.

This paper argues that changes in the financial and monetary regimes since the early 1980s may have made it more likely that financial factors in general, and the booms and busts in credit and asset prices in particular, act as drivers of economic fluctuations. As a result, the current environment may be more vulnerable to the occasional build-up of financial imbalances, ie. overextensions in (private sector) balance sheets that herald economic weakness and disinflation down the road, as they unwind, raising also the risk of financial strains and possibly even broader financial instability. Achieving simultaneously monetary and financial stability may call for some significant refinements to current policy frameworks, based on closer cooperation between prudential and monetary authorities. These refinements include a strengthening of the macroprudential orientation of regulatory and supervisory frameworks ensuring that monetary frameworks allow enough room for manoeuvre to lean pre-emptively against the build-up of the imbalances.