Interest Rates, Leverage, and Money

Apostolos Serletis, Khandokar Istiak and Periklis Gogas

Open Economies Review, 2013, vol. 24, issue 1, 78 pages

Abstract: The current mainstream approach to monetary policy is based on the New Keynesian model and is expressed in terms of a short-term nominal interest, such as the federal funds rate in the United States. It ignores the role of leverage and also downplays the role of money in basic monetary theory and monetary policy analysis. But as the federal funds rate has reached the zero lower bound and the Federal Reserve is in a liquidity trap, the issue is whether there is a useful role of leverage and monetary aggregates in monetary policy and business cycle analysis. We address these issues and argue that there is a need for financial stability policies to manage the leverage cycle and reduce the procyclicality of the financial system. We also argue that in the aftermath of the global financial crisis and Great Contraction there is a need to get away from the New Keynesian thinking and back toward a quantity theory approach to monetary policy, based on properly measured monetary aggregates, such as the new Center for Financial Stability Divisia monetary aggregates. Copyright Springer Science+Business Media New York 2013

Keywords: Leverage; Collateral rates; Divisia monetary aggregates; E43; E52; E58 (search for similar items in EconPapers)
Date: 2013
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DOI: 10.1007/s11079-012-9253-5

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