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

-Wooheon Rhee

― Abstract ―
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