Monetary policy hysteresis and the financial cycle
Claudio Borio () and
Piti Disyatat ()
No 817, BIS Working Papers from Bank for International Settlements
This paper studies the interaction between monetary policy and macroeconomic stability in a model with two distinguishing features. First, financing - cash flows - underpins all economic activity, with banks generating deposits by granting loans. Money is non-neutral as the policy interest rate anchors the real economy. Second, bank lending is subject to an endogenous boom-bust cycle due to externalities in the loan market. Together, these features imply that monetary policy may have long-lasting impact on the real economy through its in fluence on the financial cycle. In this `finance-based' economy, there is no well-defined natural rate of interest to which the economy gravitates. The possibility of a `low interest rate trap' emerges: monetary policy that leans insufficiently against the build-up of financial imbalances increases the vulnerability to financial busts over successive cycles. As a result, low rates can beget lower rates.
Keywords: monetary policy; financial cycle; money neutrality; hysteresis; natural rate of interest (search for similar items in EconPapers)
JEL-codes: E52 E58 E43 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:bis:biswps:817
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