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Monetary policy and financial stability: what role for the futures market?

Driffill, John and Rotondi, Z. and Savona, P. and Zazzara, C. (2006) Monetary policy and financial stability: what role for the futures market? Journal of Financial Stability 2 (1), pp. 95-112. ISSN 1572-3089.

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Official URL: http://dx.doi.org/10.1016/j.jfs.2005.03.001

Abstract

This paper examines interactions between monetary policy and financial stability. There is a general view that central banks smooth interest rate changes to enhance the stability of financial markets. But might this induce a moral hazard problem, and induce financial institutions to maintain riskier portfolios, the presence of which would further inhibit active monetary policy? Hedging activities of financial institutions, such as the use of interest rate futures and swap markets to reduce risk, should further protect markets against consequences of unforeseen interest rate changes. Thus, smoothing may be both unnecessary and undesirable. The paper shows by a theoretical argument that smoothing interest rates may lead to indeterminacy of the economy's rational expectations equilibrium. Nevertheless, our empirical analysis supports the view that the Federal Reserve smoothes interest rates and reacts to interest rate futures. We add new evidence on the importance for policy of alternative indicators of financial markets stress.

Item Type: Article
Keyword(s) / Subject(s): Central bank, interest rate rule, monetary policy, financial stability, macroeconomic stability, asset prices, stock market, credit spread, futures market, hedging, basis risk, federal reserve
School or Research Centre: Birkbeck Schools and Research Centres > School of Business, Economics & Informatics > Economics, Mathematics and Statistics
Depositing User: Administrator
Date Deposited: 18 Aug 2011 11:37
Last Modified: 17 Apr 2013 12:21
URI: http://eprints.bbk.ac.uk/id/eprint/4011

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