"Interest rate trap", or: Why does the central bank keep the policy rate too low for too long time?

Jin Cao () and Gerhard Illing
Additional contact information
Gerhard Illing: University of Munich. Department of Economics

No 2011/12, Working Paper from Norges Bank

Abstract: This paper provides a framework for modeling the risk-taking channel of monetary policy, the mechanism how financial intermediaries’ incentives for liquidity transformation are affected by the central bank’s reaction to financial crisis. Anticipating central bank’s reaction to liquidity stress gives banks incentives to invest in excessive liquidity transformation, triggering an "interest rate trap" - the economy will remain stuck in a long lasting period of sub-optimal,low interest rate equilibrium. We demonstrate that interest rate policy as financial stabilizer is dynamically inconsistent, and the constraint efficient outcome can be implemented by imposing ex ante liquidity requirements.

Keywords: Interest rate trap; Risk-taking channel; Systemic risk; Liquidity requirements; Macroprudential regulation (search for similar items in EconPapers)
JEL-codes: E5 G21 G28 (search for similar items in EconPapers)
Pages: 26 pages
Date: 2011-11-21
References: View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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https://www.norges-bank.no/en/news-events/news-pub ... pers/2011/WP-201112/

Related works:
Working Paper: "Interest Rate Trap", or: Why Does the Central Bank Keep the Policy Rate too Low for too Long Time? (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:bno:worpap:2011_12

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