Does Easing Monetary Policy Increase Financial Instability?

46 Pages Posted: 21 Apr 2013

See all articles by Ambrogio Cesa-Bianchi

Ambrogio Cesa-Bianchi

Bank of England

Alessandro Rebucci

Johns Hopkins University - Carey Business School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 6 versions of this paper

Date Written: February 2013

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.

JEL Classification: E44, E52, E61

Suggested Citation

Cesa-Bianchi, Ambrogio and Rebucci, Alessandro, Does Easing Monetary Policy Increase Financial Instability? (February 2013). IDB Working Paper No. IDB-WP-387. Available at SSRN: https://ssrn.com/abstract=2254456 or http://dx.doi.org/10.2139/ssrn.2254456

Ambrogio Cesa-Bianchi (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

HOME PAGE: http://https://sites.google.com/site/ambropo/

Alessandro Rebucci

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

HOME PAGE: http://carey.jhu.edu/faculty-research/faculty-directory/alessandro-rebucci-phd

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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