Optimal monetary policy with the risk-taking channel

Angela Abbate and Dominik Thaler

European Economic Review, 2023, vol. 152, issue C

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)
Date: 2023
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Citations: View citations in EconPapers (2)

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Working Paper: Optimal monetary policy with the risk-taking channel (2023)
Working Paper: Optimal Monetary Policy with the Risk-Taking Channel (2021)
Working Paper: Optimal monetary policy with the risk-taking channel (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eecrev:v:152:y:2023:i:c:s0014292122002136

DOI: 10.1016/j.euroecorev.2022.104333

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