Monetary Policy Hysteresis and the Financial Cycle

44 Pages Posted: 8 Oct 2019

See all articles by Phurichai Rungcharoenkitkul

Phurichai Rungcharoenkitkul

Bank for International Settlements (BIS) - Monetary and Economic Department

Claudio E. V. Borio

Bank for International Settlements (BIS) - Research and Policy Analysis

Piti Disyatat

Bank for International Settlements (BIS)

Date Written: October 3, 2019

Abstract

This paper studies the interaction between monetary policy and macroeconomic stability in a model with two distinguishing features. First, financing - cash flows - underpins all economic activity, with banks generating deposits by granting loans. Money is non-neutral as the policy interest rate anchors the real economy. Second, bank lending is subject to an endogenous boom-bust cycle due to externalities in the loan market. Together, these features imply that monetary policy may have long-lasting impact on the real economy through its in fluence on the financial cycle. In this 'finance-based' economy, there is no well-defined natural rate of interest to which the economy gravitates. The possibility of a 'low interest rate trap' emerges: monetary policy that leans insufficiently against the build-up of financial imbalances increases the vulnerability to financial busts over successive cycles. As a result, low rates can beget lower rates.

Keywords: monetary policy, financial cycle, money neutrality, hysteresis, natural rate of interest

JEL Classification: E52, E58, E43

Suggested Citation

Rungcharoenkitkul, Phurichai and Borio, Claudio E.V. and Disyatat, Piti, Monetary Policy Hysteresis and the Financial Cycle (October 3, 2019). BIS Working Paper No. 817, Available at SSRN: https://ssrn.com/abstract=3463904

Phurichai Rungcharoenkitkul (Contact Author)

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Claudio E.V. Borio

Bank for International Settlements (BIS) - Research and Policy Analysis ( email )

CH-4002 Basel, Basel-Stadt
Switzerland

Piti Disyatat

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

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