Monetary Policy, the Financial Cycle and Ultra-low Interest Rates

John Juselius, Claudio Borio, Piti Disyatat and Mathias Drehmann

No 55, PIER Discussion Papers from Puey Ungphakorn Institute for Economic Research

Abstract: Do the prevailing unusually and persistently low real interest rates reflect a decline in the natural rate of interest as commonly thought? We argue that this is only part of the story. The critical role of financial factors in influencing medium-term economic fluctuations must also be taken into account. Doing so for the United States yields estimates of the natural rate that are higher and, at least since 2000, decline by less. As a result, policy rates have been persistently and systematically below this measure. Moreover, we find that monetary policy, through the financial cycle, has a long-lasting impact on output and, by implication, on real interest rates. Therefore, a narrative that attributes the decline in real rates primarily to an exogenous fall in the natural rate is incomplete. The influence of monetary and financial factors should not be ignored. Exploiting these results, an illustrative counterfactual experiment suggests that a monetary policy rule that takes financial developments systematically into account during both good and bad times could help dampen the financial cycle, leading to higher output even in the long run.

Keywords: Natural Interest Rate; Financial Cycle; Monetary Policy; Credit; Business Cycle (search for similar items in EconPapers)
JEL-codes: E32 E40 E44 E50 E52 (search for similar items in EconPapers)
Pages: 61 pages
Date: 2017-03
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Citations: View citations in EconPapers (66)

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Related works:
Journal Article: Monetary Policy, the Financial Cycle, and Ultra-Low Interest Rates (2017)
Working Paper: Monetary policy, the financial cycle and ultra-low interest rates (2016)
Working Paper: Monetary policy, the financial cycle and ultralow interest rates (2016)
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