Optimal Implementable Monetary Policy in a DSGE Model with a Financial Sector

-Wooheon Rhee

¡ª Abstract ¡ª
We build a simple New Keynesian DSGE model with a financial sector and examine if the
Central Bank (henceforth CB)¡¯s responding to the shocks originated in the housing market
and/or the financial market is improving the social welfare. In order to do the analysis, we consider
a Taylor-type rule and do simulations to find the coefficients of the rule that maximizes
the social welfare, that is, a weighted average of the welfares of the patient and impatient
households. Based on the simulations, we find that (i) the CB¡¯s responding to the shocks originated
in the housing market is improving welfare by small amounts, (ii) the CB¡¯s responding to
the shocks originated in the financial market is improving the social welfare significantly; more
specifically, the social welfare increases by a factor of about four when the shocks are originated
in the lending rate and it increases by more than 5 percent when the shocks are originated in
the deposit rate.

Keywords : DSGE Model, Taylor-Type Rule, Optimal Policy, Financial Sector
JEL Classification Number : E50, G21