Optimal Monetary Policy with the Risk-Taking Channel

Angela Abbate () and Dominik Thaler

No 2137, Working Papers from Banco de España

Abstract: Empirical research suggests that lower interest rates induce banks to take higher risks. We assess analytically what this risk-taking channel implies for optimal monetary policy in a tractable New Keynesian model. We show that this channel creates a motive for the planner to stabilize the real rate. This objective conflicts with the standard inflation stabilization objective. Optimal policy thus tolerates more inflation volatility. An inertial Taylor-type reaction function becomes optimal. We then quantify the significance of the risk-taking channel for monetary policy in an estimated medium-scale extension of the model. Ignoring the channel when designing policy entails non-negligible welfare costs (0.7% lifetime consumption equivalent).

Keywords: risk-taking channel; optimal monetary policy; inertial policy rate (search for similar items in EconPapers)
JEL-codes: E44 E52 (search for similar items in EconPapers)
Pages: 53 pages
Date: 2021-10
New Economics Papers: this item is included in nep-ban, nep-dge, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Optimal monetary policy with the risk-taking channel (2023)
Working Paper: Optimal monetary policy with the risk-taking channel (2023)
Working Paper: Optimal monetary policy with the risk-taking channel (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:bde:wpaper:2137

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