Inflation Conservatism and Financial Frictions

Which policy mandate should be assigned to central banks in the face of financial frictions?
In a New Keynesian DSGE model with an accelerated cost channel, the presence of financial frictions generates a flatter Phillips curve and renders forward-looking behavior more relevant for macroeconomic dynamics. As a consequence, monetary policy performance under discretion deteriorates substantially. A conservative central banker who places a larger weight on inflation stabilization than society is able to overcome the stabilization bias and closely mimics the optimal policy under commitment. The required degree of inflation conservatism increases in the extent to which financial frictions are present.