Abstract
This article presents evidence on the relationship between price and financial stability. We construct an annual index of financial conditions for the United States, 1790–1997, and estimate the effect of aggregate price shocks on the index using a dynamic ordered probit model. We find that price‐level shocks contributed to financial instability during 1790–1933 and that inflation rate shocks contributed to financial instability during 1980–97. The size of the aggregate price shock needed to alter financial conditions depends on the institutional environment, but we conclude that a monetary policy focused on price stability would contribute to financial stability.
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