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Monetary policy hysteresis and the financial cycle

Phurichai Rungcharoenkitkul, Claudio Borio () and Piti Disyatat ()

No 817, BIS Working Papers from Bank for International Settlements

Abstract: 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
Date: 2019-10
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