Does Easing Monetary Policy Increase Financial Instability?

Ambrogio Cesa-Bianchi and Alessandro Rebucci ()

No 2015/139, 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: WP; federal funds rate; monetary policy; monopolistic competition; mortgage market; Macro-prudential policies; financial crises; credit frictions; interest rate rigidities; interest rate stickiness; risk-free interest rate; lending interest rate; Taylor-type interest rate rule; staggered interest rate setting; policy authority; stickiness result; interest rate repayment; Financial sector stability; Financial frictions; Central bank policy rate; Collateral; Global financial crisis of 2008-2009; Global (search for similar items in EconPapers)
Pages: 47
Date: 2015-06-26
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
http://www.imf.org/external/pubs/cat/longres.aspx?sk=43033 (application/pdf)

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)
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:imf:imfwpa:2015/139

Ordering information: This working paper can be ordered from
http://www.imf.org/external/pubs/pubs/ord_info.htm

Access Statistics for this paper

More papers in IMF Working Papers from International Monetary Fund International Monetary Fund, Washington, DC USA. Contact information at EDIRC.
Bibliographic data for series maintained by Akshay Modi ().