Capital regulation, risk-taking and monetary policy: A missing link in the transmission mechanism?

Claudio Borio and Haibin Zhu

Journal of Financial Stability, 2012, vol. 8, issue 4, 236-251

Abstract: Few areas of monetary economics have been studied as extensively as the transmission mechanism. The literature on this topic has evolved substantially over the years, following the waxing and waning of conceptual frameworks and the changing characteristics of the financial system. In this paper, taking as a starting point a brief overview of the extant work on the interaction between capital regulation, the business cycle and the transmission mechanism, we offer some broader reflections on the characteristics of the transmission mechanism in light of the evolution of the financial system. We argue that insufficient attention has so far been paid to the link between monetary policy and the perception and pricing of risk by economic agents—what might be termed the “risk-taking channel” of monetary policy. We develop the concept, compare it with current views of the transmission mechanism, explore its mutually reinforcing link with “liquidity” and analyse its interaction with monetary policy reaction functions. We argue that changes in the financial system and prudential regulation may have increased the importance of the risk-taking channel and that prevailing macroeconomic paradigms and associated models are not well suited to capturing it, thereby also reducing their effectiveness as guides to monetary policy.

Keywords: Risk-taking channel; Transmission mechanism; Capital regulation; Procyclicality (search for similar items in EconPapers)
JEL-codes: E44 E51 E52 G12 G21 G28 (search for similar items in EconPapers)
Date: 2012
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (829)

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Working Paper: Capital regulation, risk-taking and monetary policy: a missing link in the transmission mechanism? (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finsta:v:8:y:2012:i:4:p:236-251

DOI: 10.1016/j.jfs.2011.12.003

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