The Financial Stability Dark Side of Monetary Policy

Piergiorgio Alessandri, Antonio Conti () and Fabrizio Venditti

No 1601, BCAM Working Papers from Birkbeck Centre for Applied Macroeconomics

Abstract: Market risk premia play an important role in the transmission of monetary policy. If the transmission were to work asymmetrically for positive and negative shocks, monetary authorities would face a problematic trade-off: a temporary stimulus could boost the economy in the short run, but at the same time sow the seeds of a painful medium-run market reversal (the "financial stability dark side" of monetary policy of Stein, 2014). We study the relation between interest rates, credit spreads and output in the U.S. using monthly data and a range of nonlinear dynamic models. We find clear signs of a reduced-form asymmetry, but no evidence in support of the causal mechanism that underpins the 'dark side' argument: spreads rise noticeably ahead of economic slowdowns but they do not appear to cause them directly, particularly if they move in response to monetary shocks. This suggests that the asymmetry is best interpreted as a purely predictive relation, with markets being particularly sensitive to bad economic news; and that it creates no complications for monetary policy or for the exit strategy from monetary accommodation.

Keywords: risk premia; asymmetry; monetary policy; financial stability; local projections. (search for similar items in EconPapers)
JEL-codes: C32 E32 F34 (search for similar items in EconPapers)
Date: 2016-05
New Economics Papers: this item is included in nep-mac and nep-mon
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Citations: View citations in EconPapers (2)

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Working Paper: The financial stability dark side of monetary policy (2017)
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