Monetary Policy and Leverage Shocks

Forthcoming in: International Journal of Finance and Economics

University of Calgary Working Paper 2016-45

33 Pages Posted: 30 Nov 2016

See all articles by Khandokar Istiak

Khandokar Istiak

University of South Alabama - Mitchell College of Business - Department of Economics and Finance

Apostolos Serletis

University of Calgary - Department of Economics

Date Written: November 28, 2016

Abstract

The current mainstream approach to monetary policy in the United States is based on the new Keynesian model and is expressed in terms of the federal funds rate. It ignores the role of financial intermediary leverage (or collateral rates). But as the federal funds rate has reached the zero lower bound, the issue is whether there is a useful role of leverage in monetary policy and business cycle analysis. Motivated by these considerations and by recent financial intermediary asset pricing theories, in this paper we investigate the macroeconomic effects of broker-dealer leverage and the interdependence between monetary policy and broker-dealer leverage in the context of a structural vector autoregression model, using quarterly U.S. data over the period from 1967:1 to 2014:3. We address the simultaneity problem of identifying monetary policy and leverage shocks by using a combination of short-run and long-run restrictions. We also use the sign restrictions approach to the identification of shocks to distinguish between leverage supply and leverage demand shocks, as one would expect the macroeconomic effects of these two types of leverage shocks to be quite different. Our results show that monetary policy and broker-dealer leverage demand shocks produce results that capture reasonable macroeconomic dynamics.

Keywords: Leverage, Security Broker-Dealers, Asset Pricing, Monetary Policy

JEL Classification: E43, E52, E61, G12

Suggested Citation

Istiak, Khandokar and Serletis, Apostolos, Monetary Policy and Leverage Shocks (November 28, 2016). Forthcoming in: International Journal of Finance and Economics; University of Calgary Working Paper 2016-45. Available at SSRN: https://ssrn.com/abstract=2876694 or http://dx.doi.org/10.2139/ssrn.2876694

Khandokar Istiak

University of South Alabama - Mitchell College of Business - Department of Economics and Finance ( email )

College of Business and Management Studies
Mobile, AL 36688
United States

Apostolos Serletis (Contact Author)

University of Calgary - Department of Economics ( email )

2500 University Drive, NW
Calgary, Alberta T2N 1N4
Canada
403 220-4091 (Phone)
403 282-5262 (Fax)

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