Stabilizing the financial cycle: the role of monetary policy in a semi-structural model

Abstract

Purpose The 2008 financial crisis highlighted the crucial importance of financial stability, pointing to the close connection between the real cycle and the business cycle. Extending the work (Achmakou and Hachimi Alaoui, 2024), this paper aims to analyze the role of monetary policy in preserving financial resilience, focusing on its interaction with the financial cycle. It illustrates how financial frictions and the endogenous risk premium amplify and prolong the effects of exogenous shocks. Design/methodology/approach To attenuate these consequences, this paper considers the adoption of an augmented Taylor rule incorporating a financial stability component. A semi-structural general equilibrium model is developed, combining the estimation of coefficients related to the financial cycle and the calibration of other parameters. Estimation is based on quarterly Moroccan data from 2007q1 to 2019q4, without considering the post-COVID period to avoid biases linked to the health shock. Findings The results reveal that the financial stability objective incorporated in policy rule significantly mitigates the amplification of shocks, improves inflation control. Overall, the study concludes that there is a case for expanding the monetary policy mandate while recognizing its complementarity with macroprudential tools. Originality/value This paper contributes to the literature on financial stability in emerging economies by examining the role of monetary policy in enhancing financial resilience.