Eduardo Amaral · 2021 · Ph.D. thesis, Chapter 1 · PUC-Rio
Monetary policy is often said to be responsible for setting or targeting the nominal risk-free interest rate of an economy even though it is operated in a risky environment through assets that may be risky. This paper studies how policy-asset risk can be transmitted to monetary policy under a neo-Wisksellian approach. We introduce risk in the policy asset of a partial equilibrium model and show that monetary policy power w.r.t prices and inflation is reduced, as well as a positive correlation between inflation and that risk emerges. Moreover, uncompensated risk premium induces an inflationary bias. These results constitute a novel argument in favor of a more hawkish stance in case of a fiscal or political crisis, since monetary policy can only be conditionally active in the presence of risk in its underlying asset. Overall, monetary policy’s activeness depends on whether the central bank sets and targets a risky or a risk-free rate.
Amaral, Eduardo G. C. (2021). “Interest, Prices, and Risk.” Chapter 1 of Essays in Monetary Policy with Risky Assets, Ph.D. thesis, Pontifical Catholic University of Rio de Janeiro (PUC-Rio).
@unpublished{Amaral2021InterestPricesRisk,
author = {Amaral, Eduardo G. C.},
title = {Interest, Prices, and Risk},
year = {2021},
note = {Chapter 1 of Essays in Monetary Policy with Risky Assets, Ph.D. thesis, PUC-Rio},
url = {https://github.com/edugca/PhD_Thesis/raw/main/Ch%201%20%E2%80%93%20Interest%2C%20Prices%2C%20and%20Risk.pdf}
}