Financial friction and optimal monetary policy: analysis of DSGE model with financial friction and price sticky

The paper analyzes the effectiveness of standard and augmented monetary policies in the case of financial and real shocks. We use a Dynamic Stochastic General Equilibrium Model (DSGE model) with various financial frictions and price sticky. Based on this model, we examined the effectiveness of four augmented Taylor rules with five policy regimes. Our results show that, relative to the standard Taylor rule, the effect of the boom-bust process on financial variables and output is improved when the Central Bank follows an augmented Taylor rule, but at the expense of inflation. We also find that leaning against the wind (LATW), in particular against credit to GDP growth, helps the Central Bank of Tunisia (CBT) to achieve its mandate following financial shocks, even if the CBT only cares about price and output stabilization (LF1). Moreover, we show that LATW should be coupled with a strong reaction to inflation and an aggressive reaction to the credit-to-GDP ratio. The result of this paper represents a starting point for Tunisian policymakers to examine and evaluate two monetary policy rules under various regimes in Tunisia, especially since the CBT does not have, until today, a specific DSGE model. © The Author(s), under exclusive licence to Springer Nature Switzerland AG 2024.