Does easing monetary policy increase financial instability?

Ambrogio Cesa-Bianchi and Alessandro Rebucci ()

No 570, Bank of England working papers from Bank of England

Abstract: This paper develops a model featuring both a macroeconomic and a financial friction that speaks to the interaction between monetary and macroprudential policy and to the role of US monetary and regulatory policy in the run up to the Great Recession. There are two main results. First, real interest rate rigidities in a monopolistic banking system increase the probability of a financial crisis (relative to the case of flexible interest rate) in response to contractionary shocks to the economy, while they act as automatic macroprudential stabilizers in response to expansionary shocks. Second, when the interest rate is the only available policy instrument, a monetary authority subject to the same constraints as private agents cannot always achieve a (constrained) efficient allocation and faces a trade-off between macroeconomic and financial stability in response to contractionary shocks. An implication of our analysis is that the weak link in the US policy framework in the run up to the Global Recession was not excessively lax monetary policy after 2002, but rather the absence of an effective second policy instrument aimed at preserving financial stability.

Keywords: Macroprudential policies; monetary policy; financial crises; frictions; interest rate rigidities. (search for similar items in EconPapers)
JEL-codes: E44 E52 E61 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2015-12-11
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Related works:
Journal Article: Does easing monetary policy increase financial instability? (2017)
Working Paper: Does Easing Monetary Policy Increase Financial Instability? (2016)
Working Paper: Does Easing Monetary Policy Increase Financial Instability? (2015)
Working Paper: Does Easing Monetary Policy Increase Financial Instability? (2013)
Working Paper: Does Easing Monetary Policy Increase Financial Instability? (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:0570

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