The financial accelerator and monetary policy rules

The ability of financial frictions to amplify the output response of monetary policy, as in the financial accelerator model of Bernanke et al (1999), is analysed for a wider class of policy rules where the policy interest rate responds to both inflation and the output gap. When policy makers respond to the output gap as well as inflation, the standard financial accelerator model reacts less to an interest rate shock than does a comparable model without an operational financial accelerator mechanism. In recessions, when firm-specific volatility rises, financial acceleration due to financial frictions is further reduced, even under pure inflation targeting.