Quantifying Financial Stability Trade-Offs for Monetary Policy : A Quantile VAR Approach

We propose a novel empirical approach to inform monetary policymakers about the potential effects of policy action when facing trade-offs between financial and macroeconomic stability. We estimate a quantile vector autoregression (QVAR) for the euro area covering the real economy, monetary policy and measures of ex ante and ex post systemic risk representing financial stability. Policy implications are derived from scenario analyses where the associated costs and benefits are functions of the projected paths of the potentially asymmetric distributions of inflation and economic growth, allowing us to take a risk management perspective. One exercise considers the intertemporal financial stability trade-off in the context of the global financial crisis, where we find ex post evidence in favour of monetary policy leaning against the financial cycle. Another exercise considers the short-term financial stability trade-off when deciding the appropriate speed of monetary policy tightening to combat inflationary pressures in a fragile financial environment