"Low for Long" and Risk-Taking
Departmental Papers, November 24, 2020
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Bibliographic details
- Authors: Tobias Adrian
- Published: November 24, 2020
- Series: Departmental Papers
- DOI: https://doi.org/10.5089/9781513556062.087
Summary
- The COVID-19 pandemic is causing an unprecedented worldwide economic contraction, leading central banks to reduce interest rates to historically low levels and making unconventional monetary policies—including “low for long” interest rates and asset purchases—increasingly common.
- These policies are argued to be efficient because they encourage increased risk-taking, and they may have, if unintentionally, increased medium- and long-run macro-financial vulnerabilities.
- The paper argues that the resulting trade-offs need to be carefully accounted for in monetary policy models and outlines how that can be achieved in practice.
Main arguments and findings
- Unconventional monetary policies such as sustained “low for long” interest rates and asset purchases promote increased risk-taking by economic agents.
- Increased risk-taking can improve efficiency in the short run but may raise macro-financial vulnerabilities over the medium and long run.
- Monetary policy models should explicitly incorporate the trade-offs between supporting economic activity and encouraging financial risk-taking.
- The paper outlines practical approaches to account for these trade-offs within monetary-policy frameworks.
Policy implications and recommendations
- Monetary-policy decision makers should augment standard policy rules to account for financial risk and risk-taking behavior.
- Monetary policy frameworks (including the NKV framework) should integrate financial sector risk, macroprudential policy interactions, and the monetary-policy transmission mechanism.
- Policy design should consider interactions between monetary policy and macroprudential policy instruments to mitigate medium- and long-run vulnerabilities arising from prolonged low interest rates.
Subjects, keywords, and technical focus
- Subject: Financial sector policy and analysis; Monetary policy; Production
- Keywords: augmented monetary-policy rule, decision makers, financial risk, Financial sector risk, Financial Stability, Global, growth distribution, Macroprudential policy, Macroprudential policy instruments, Monetary Policy, monetary policy making, monetary-policy decision makers, monetary-policy transmission mechanism, NKV framework, NKV model, Output gap, Production growth, Risk-Taking, rule in the NKV framework