Publication detail

Time-Varying Monetary-Policy Rules and Financial Stress: Does Financial Instability Matter for Monetary Policy?

Author(s): PhDr. Jaromír Baxa Ph.D., Vašíček, Bořek
prof. Roman Horváth Ph.D., Vašíček, Bořek
Type: Others
Year: 2011
Number: 3
ISSN / ISBN: ISSN 1803-7070
Published in: Czech National Bank Working Paper No. 3/2011
Publishing place: Praha
Keywords: Endogenous regressors, financial stress, monetary policy, Taylor rule, time-varying parameter model.
JEL codes: E43, E52, E58
Suggested Citation: Baxa, J., Horvath, R., Vašíček, B. (2011). Time-Varying Monetary-Policy Rules and Financial Stress: Does Financial Instability Matter for Monetary Policy?. Czech National Bank Working Paper No. 3/2011, July 2011.
Abstract: We examine whether and how selected central banks responded to episodes of financial
stress over the last three decades. We employ a new monetary-policy rule estimation
methodology which allows for time-varying response coefficients and corrects for
endogeneity. This flexible framework applied to the USA, the UK, Australia, Canada, and
Sweden, together with a new financial stress dataset developed by the International
Monetary Fund, not only allows testing of whether central banks responded to financial
stress, but also detects the periods and types of stress that were the most worrying for
monetary authorities and quantifies the intensity of the policy response. Our findings
suggest that central banks often change policy rates, mainly decreasing them in the face
of high financial stress. However, the size of the policy response varies substantially over
time as well as across countries, with the 2008–2009 financial crisis being the period of
the most severe and generalized response. With regard to the specific components of
financial stress, most central banks seemed to respond to stock-market stress and bank
stress, while exchange-rate stress is found to drive the reaction of central banks only in
more open economies.
Downloadable: CNB WP 2011/3
February 2023




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