Introducing Financial Stability to Monetary Policy: a FAVAR approach

The issue of using monetary policy for financial stability purposes is hotly contested. The world financial and economic crisis has highlighted the interconnectedness of economic policies and a new debate began on their impact on financial stability. The crisis was, among other; a reminder that price stability is not sufficient condition for financial stability and widely used New Keynesian Models do not stand so firmly nowadays. We address this issue by analyzing implications of monetary policies actions on financial stability in the Czech economy using factor-augmented vector autoregression approach (FAVAR). The main takeaway from our preliminary evidence is that higher interest rates have a negative effect on financial stability in the short run, but may have positive effects in the medium to long-run.