Optimal monetary policy with the risk-taking channel

Angela Abbate and Dominik Thaler

No 2772, Working Paper Series from European Central Bank

Abstract: Empirical research suggests that lower interest rates induce banks to take higher risks. We assess analytically what this risk-taking channel implies for optimal monetary policy in a tractable New Keynesian model. We show that this channel creates a motive for the planner to stabilize the real rate. This objective conflicts with the standard inflation stabilization objective. Optimal policy thus tolerates more inflation volatility. An inertial Taylor-type reaction function becomes optimal. We then quantify the significance of the risk-taking channel for monetary policy in an estimated medium-scale extension of the model. Ignoring the channel when designing policy entails non-negligible welfare costs (0.7%lifetime consumption equivalent). JEL Classification: E44, E52

Keywords: inertial policy rate; optimal monetary policy; risk-taking channel (search for similar items in EconPapers)
Date: 2023-02
New Economics Papers: this item is included in nep-ban, nep-dge and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
https://www.ecb.europa.eu//pub/pdf/scpwps/ecb.wp2772~2ed9bb314f.en.pdf (application/pdf)

Related works:
Journal Article: Optimal monetary policy with the risk-taking channel (2023)
Working Paper: Optimal Monetary Policy with the Risk-Taking Channel (2021)
Working Paper: Optimal monetary policy with the risk-taking channel (2021)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20232772

Access Statistics for this paper

More papers in Working Paper Series from European Central Bank 60640 Frankfurt am Main, Germany. Contact information at EDIRC.
Bibliographic data for series maintained by Official Publications ().