Does Easing Monetary Policy Increase Financial Instability?

By Ambrogio Cesa-Bianchi, Alessandro Rebucci

June 26, 2015

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Format: Chicago

Ambrogio Cesa-Bianchi, and Alessandro Rebucci. Does Easing Monetary Policy Increase Financial Instability?, (USA: International Monetary Fund, 2015) accessed September 18, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper develops a model featuring both a macroeconomic and a financial friction that speaks to the interaction between monetary and macro-prudential policies. There are two main results. First, real interest rate rigidities in a monopolistic banking system have an asymmetric impact on financial stability: they increase the probability of a financial crisis (relative to the case of flexible interest rate) in response to contractionary shocks to the economy, while they act as automatic macro-prudential stabilizers in response to expansionary shocks. Second, when the interest rate is the only available policy instrument, a monetary authority subject to the same constraints as private agents cannot always achieve a (constrained) efficient allocation and faces a trade-off between macroeconomic and financial stability in response to contractionary shocks. An implication of our analysis is that the weak link in the U.S. policy framework in the run up to the Global Recession was not excessively lax monetary policy after 2002, but rather the absence of an effective regulatory framework aimed at preserving financial stability.

Subject: Banking, Central bank policy rate, Collateral, Economic theory, Financial crises, Financial frictions, Financial institutions, Financial sector policy and analysis, Financial sector stability, Financial services, Global financial crisis of 2008-2009, Mortgages

Keywords: Central bank policy rate, Collateral, Credit frictions, Federal funds rate, Financial crises, Financial frictions, Financial sector stability, Global, Global financial crisis of 2008-2009, Interest rate repayment, Interest rate rigidities, Interest rate stickiness, Lending interest rate, Macro-prudential policies, Monetary policy, Monopolistic competition, Mortgage market, Policy authority, Risk-free interest rate, Staggered interest rate setting, Stickiness result, Taylor-type interest rate rule, WP

Publication Details

Pages:

47
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2015/139
Stock No:

WPIEA2015139
ISBN:

9781513588490
ISSN:

1018-5941

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