## Monetary and Macroprudential Policy with Endogenous Risk

_IMF Working Papers, November 13, 2020_

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## Bibliographic details
- Authors: Tobias Adrian, Fernando Duarte, Nellie Liang, Pawel Zabczyk
- Published: November 13, 2020
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781513561066.001

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### Authors and Publication
- Tobias Adrian, Fernando Duarte, Nellie Liang, Pawel Zabczyk
- November 13, 2020
- Working Paper No. 2020/236, Issue: 236, Volume: 2020
- Pages: 55
- DOI: https://doi.org/10.5089/9781513561066.001
- ISBN: 9781513561066
- ISSN: 1018-5941

### Research question and model extension
- Extends the New Keynesian (NK) model to include endogenous risk.
- Introduces a vulnerability channel of monetary policy whereby lower interest rates affect not only intertemporal consumption choices but also conditional output risk through their impact on risk-taking.
- The model is calibrated/validated to fit the conditional output gap distribution and to account for medium-term increases in downside risks under loose financial conditions.

### Key findings
- Lower interest rates:
  - Shift consumption intertemporally.
  - Increase conditional output risk by inducing greater risk-taking, creating a vulnerability channel of monetary policy.
- The extended model can account for medium-term increases in downside risks when financial conditions are loose.
- Policy prescriptions differ markedly from the standard NK model:
  - Monetary policy that focuses purely on inflation and output-gap stabilization can lead to instability in the presence of endogenous risk.
- Macroprudential measures:
  - Can mitigate the intertemporal risk-return tradeoff created by the vulnerability channel.

### Policy implications and recommendations
- Reassess monetary policy frameworks that target only inflation and the output gap, given the instability risk from endogenous risk-taking.
- Employ macroprudential measures alongside monetary policy to address the vulnerability channel and to mitigate medium-term downside risks arising from loose financial conditions.
- Consider the intertemporal risk-return tradeoff in policy design, recognizing that lower interest rates may raise systemic vulnerability via risk-taking responses.

*IMF Working Paper: "Monetary and Macroprudential Policy with Endogenous Risk", Tobias Adrian, Fernando Duarte, Nellie Liang, Pawel Zabczyk, November 13, 2020, Working Paper No. 2020/236, DOI: https://doi.org/10.5089/9781513561066.001*

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