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Does easing monetary policy increase financial instability?

Ambrogio Cesa-Bianchi () and Alessandro Rebucci ()

Journal of Financial Stability, 2017, vol. 30, issue C, 111-125

Abstract: This paper develops a model featuring both a macroeconomic and a financial friction that speaks to the interaction between monetary and macro-prudential policy and to the role of US monetary and regulatory policy in the run up to the Subprime mortgage crisis. There are two main results. First, interest rate rigidities in a monopolistic banking system 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 instrument, monetary policy faces a trade-off between macroeconomic and financial stability. This trade off is both qualitative and quantitative in response to contractionary shocks, while it is only quantitative in response to positive shocks. We show that a second instrument, such as a Pigouvian tax on credit to households on the demand side of the market, is needed to restore efficiency in the economy when both frictions are at work.

Keywords: Macro-prudential policies; Monetary policy; Financial crises; Financial regulation; Pecuniary externality; Interest rate rigidities; Subprime mortgage crisis (search for similar items in EconPapers)
JEL-codes: E44 E52 E61 (search for similar items in EconPapers)
Date: 2017
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Related works:
Working Paper: Does Easing Monetary Policy Increase Financial Instability? (2016) Downloads
Working Paper: Does easing monetary policy increase financial instability? (2015) Downloads
Working Paper: Does Easing Monetary Policy Increase Financial Instability? (2015) Downloads
Working Paper: Does Easing Monetary Policy Increase Financial Instability? (2013) Downloads
Working Paper: Does Easing Monetary Policy Increase Financial Instability? (2013) Downloads
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