Monetary Policy with Investment-Saving Imbalances

Financial instability is the new challenge for monetary policy. Most studies indicate that the typical patterns of financial crises include prolonged unwinding of investment-saving imbalances (ISI). These phenomena challenge modern monetary policy also because they are not contemplated by its theoretical framework of continuous intertemporal equilibrium. This paper's aim is to take a first step into the analysis of monetary policy in the context of ISI. First, a dynamic model of a flex-price, competitive economy is presented where ISI are allowed to develop as a result of the mismatch between the interest rate controlled by the central bank and the quot;natural ratequot; consistent with investment-saving equilibrium. Upon introducing different types of Taylor rules, some indications for monetary policy conduct emerge which are at variance with the standard view: in particular, the robustness of quot;adaptivequot; instead of quot;optimizingquot; interest-rate rules when direct information on the quot;natural ratequot; is not available; the central bank's bounded responsiveness to excess inflation/deflation (or the irrelevance of the so-called quot;Taylor principlequot;); the emergence of a trade-off between small gaps vs. smooth paths in the design of the Taylor rule as a convergence control tool