Does Easing Monetary Policy Increase Financial Stability?

41 Pages Posted: 21 Oct 2019

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: April 17, 2017

Abstract

This paper develops a model featuring both a macroeconomic and a financial friction that speaks to the interaction between monetary and macro-prudential policy and to the role of US monetary and regulatory policy in the run up to the Subprime mortgage crisis. There are two main results. First, interest rate rigidities in a monopolistic banking system increase the probability of a financial crisis (relative to the case of flexible interest rate) in response to contractionary shocks to the economy, while they act as automatic macro-prudential stabilizers in response to expansionary shocks. Second, when the interest rate is the only available instrument, monetary policy faces a trade-off between macroeconomic and financial stability. This trade off is both qualitative and quantitative in response to contractionary shocks, while it is only quantitative in response to positive shocks. We show that a second instrument, such as a Pigouvian tax on credit to households on the demand side of the market, is needed to restore efficiency in the economy when both frictions are at work.

Keywords: Macro-prudential policies, Monetary policy, Financial crises, Financial regulation, Pecuniary externality, Interest rate rigidities, Subprime mortgage crisis

JEL Classification: E44, E52, E61

Suggested Citation

Cesa-Bianchi, Ambrogio and Rebucci, Alessandro, Does Easing Monetary Policy Increase Financial Stability? (April 17, 2017). Journal of Financial Stability, Vol. 30, 2017. Available at SSRN: https://ssrn.com/abstract=3407709

Ambrogio Cesa-Bianchi

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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

Alessandro Rebucci (Contact Author)

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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