Monetary Policy and Financial Stability: What Role for the Futures Market?

Universita di Ferrara Economia Istituzioni Territorio Working Paper No. 15/2005

33 Pages Posted: 28 Apr 2005

See all articles by John Driffill

John Driffill

University of London - Birkbeck College; Centre for Economic Policy Research (CEPR)

Paolo Savona

Luiss University

Zeno Rotondi

UNICREDIT; LUISS Guido Carli University

Cristiano Zazzara

Libera Università degli Studi Sociali (LUISS) Guido Carli - Fondo Interbancario di Tutela dei Depositi and Instituto di Studi Economici

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.

Keywords: Central Bank, Interest Rate Rule, Monetary Policy, Financial Stability, Macroeconomic Stability, Asset Prices, Stock Market, Credit Spread, Futures Market, Hedging, Basis Risk, Federal Reserve

JEL Classification: E44, E52, E58, G12, G13

Suggested Citation

Driffill, John and Savona, Paolo and Rotondi, Zeno and Zazzara, Cristiano, Monetary Policy and Financial Stability: What Role for the Futures Market?. Universita di Ferrara Economia Istituzioni Territorio Working Paper No. 15/2005, Available at SSRN: https://ssrn.com/abstract=707403 or http://dx.doi.org/10.2139/ssrn.707403

John Driffill (Contact Author)

University of London - Birkbeck College ( email )

London, WC1E 7HX
United Kingdom
+44 20 7631 6417 (Phone)
+44 20 7631 6416 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Paolo Savona

Luiss University ( email )

via de' Crociferi n. 41
00187 Rome, Roma
Italy

Zeno Rotondi

UNICREDIT ( email )

VIA SPECCHI 16
ROME, 00186
Italy

HOME PAGE: http://docenti.luiss.it/rotondi

LUISS Guido Carli University ( email )

Via O. Tommasini 1
Rome, Roma 00100
Italy

Cristiano Zazzara

Libera Università degli Studi Sociali (LUISS) Guido Carli - Fondo Interbancario di Tutela dei Depositi and Instituto di Studi Economici ( email )

00162 Rome, Roma
Italy
+39 06 699 86 402 (Phone)

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