Does%20Easing%20Monetary%20Policy%20Increase%20Financial%20Instability%3F

Working Papers

Does Easing Monetary Policy Increase Financial Instability?


CODE: IDB-WP-387
AUTHOR(s): Cesa-Bianchi, Ambrogio , Rebucci, Alessandro
PUBLISHED: February 2013
LANGUAGE: English
RELATED TOPICS: Macroeconomics
DOWNLOAD FILE IN: English

Abstract:

This paper develops a model featuring both a macroeconomic and a financial stability objective that speaks to the interaction between monetary and macroprudential policies. First, we find that interest rate rigidities in a monopolistic banking system have an asymmetric impact on financial stability: they lead to greater financial instability in response to contractionary shocks, while they act as an automatic financial stabilizer in response to expansionary shocks. Second, we find that when the policy interest rate is the only 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. This has important implications for the role played by U.S. monetary policy in the run-up to the global financial crisis: the model suggests that the weak link in the U.S. policy framework was not the monetary policy stance after 2002, but rather the absence of an effective second policy pillar aimed at preserving financial stability.

Related Research by JEL Codes:
(or click here to find research by JEL Codes)
  • Global Recovery and Monetary Normalization: Escaping a Chronicle Foretold? (Main Messages)
    Brochures
    IDB-BR-122 - March 2014

    Monetary normalization may be a chronicle foretold, but countries still have the power to influence the outcome for their own economies. This report focuses on the risks Latin American and Caribbean countries face and how they can reduce vulnerabilities and enhance opportunities. (View publication)

  • Global Recovery and Monetary Normalization: Escaping a Chronicle Foretold?
    Annual Report
    IDB-AR-109 - March 2014

    Monetary normalization may be a chronicle foretold, but countries still have the power to influence the outcome for their own economies. This report focuses on the risks Latin American and Caribbean countries face and how they can reduce vulnerabilities and enhance opportunities. (View publication)

  • Inflation Targeting in Colombia, 2002-2012
    Working Papers
    IDB-WP-487 - February 2014

    After decades using monetary aggregates as the main instrument of monetary policy and having different varieties of crawling peg exchange rate regimes, Colombia adopted a full-fledged inflation-targeting (IT) regime in 1999, with inflation as the nominal anchor, a floating exchange rate, and the short-term interest rate as the main instrument. This paper examines the experience of the Colombian Ce ... (View publication)

Hello, Welcome to the IDB!

Please join our mailing list by simply entering your email below.