Monetary Policy and the Asset Risk-Taking Channel
58 Pages Posted: 8 Feb 2018
Date Written: February 8, 2018
How important is the risk-taking channel for monetary policy? To answer this question, we develop and estimate a quantitative monetary DSGE model where banks choose excessively risky investments, due to an agency problem which distorts banks’ incentives. As the real interest rate declines, these distortions become more important and excessive risk taking increases, lowering the efficiency of investment. We show that this novel transmission channel generates a new and quantitatively significant monetary policy trade-off between inflation and real interest rate stabilization: it is optimal for the central bank to tolerate greater inflation volatility in exchange for lower risk taking.
Keywords: Bank Risk, Monetary Policy, DSGE Models
JEL Classification: E12, E44, E58
Suggested Citation: Suggested Citation