Monetary Policy and Excessive Bank Risk Taking
CentER Discussion Paper Series No. 2010-30S
27 Pages Posted: 18 Mar 2010
Date Written: March 1, 2010
If monetary policy is to aim at financial stability, how would it change? To analyze this question, this paper develops a general-form, axiomatic framework. Financial stability objectives are shown to make a monetary authority more conservative and more aggressive. Conservative as it sets higher rates on average. And aggressive because, in reaction to negative shocks, cuts are deeper but shorter-lived than otherwise. Keeping cuts short is crucial as bank risk responds primarily to stable low rates. Within the short span, cuts then must be deep to achieve standard objectives.
Keywords: Monetary policy, Financial stability
JEL Classification: E52, G01, G21
Suggested Citation: Suggested Citation