Monetary policy, financial stability and interest rate rules

Abstract

This paper investigates the empirical properties of simple interest rate rules that embed either ‘backward’ or ‘forward’ interest rate smoothing. Such interest rate rules can be rationalised as the operative reaction functions used by central banks pursuing monetary policy and financial stability targets. This paper considers the implications of banks’ risk management practices for monetary policy and derives interest rate rules by modelling the desire of the central bank to stabilise different definitions of the ‘basis’ risk as a contribution to financial stability.