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Does Easing Monetary Policy Increase Financial Instability?

Ambrogio Cesa-Bianchi () and Alessandro Rebucci ()

No 15/139, IMF Working Papers from International Monetary Fund

Abstract: This paper develops a model featuring both a macroeconomic and a financial friction that speaks to the interaction between monetary and macro-prudential policies. There are two main results. First, real interest rate rigidities in a monopolistic banking system have an asymmetric impact on financial stability: they 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 macro-prudential 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 U.S. 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 regulatory framework aimed at preserving financial stability.

Keywords: Financial crises; Financial stability; Econometric models; Automatic stabilizers; Real interest rates; Macroprudential Policy; Monetary policy; United States; Macro-prudential policies, credit frictions, interest rate rigidities, interest, interest rate, interest rates, Financial Markets and the Macroeconomy, Monetary Policy (Targets, Instruments, and Effects), (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2015-06-26
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Related works:
Journal Article: Does easing monetary policy increase financial instability? (2017) Downloads
Working Paper: Does Easing Monetary Policy Increase Financial Instability? (2016) Downloads
Working Paper: Does easing monetary policy increase financial instability? (2015) Downloads
Working Paper: Does Easing Monetary Policy Increase Financial Instability? (2013) Downloads
Working Paper: Does Easing Monetary Policy Increase Financial Instability? (2013) Downloads
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