Financial Stability Policies and Bank Lending: Quasi-Experimental Evidence from Federal Reserve Interventions in 1920-21

122 Pages Posted: 4 Dec 2020 Last revised: 18 Nov 2021

See all articles by Kilian Rieder

Kilian Rieder

Oesterreichische Nationalbank (Eurosystem)

Date Written: December, 2020

Abstract

I estimate the comparative causal effects of monetary policy \leaning against the wind" (LAW) and macroprudential policy on bank-level lending and leverage by drawing on a single natural experiment. In 1920, when U.S. monetary policy was still decentralized, four Federal Reserve Banks implemented a conventional rate hike to address financial stability concerns. Another four Reserve Banks resorted to macroprudential policy with the same goal. Using sharp geographic regression discontinuities, I exploit the resulting policy borders with the remaining four Federal Reserve districts which did not change policy stance. Macroprudential policy caused both bank-level lending and leverage to fall significantly (by 11%-14%), whereas LAW had only weak and, in some areas, even perverse effects on these bank-level outcomes. I show that the macroprudential tool reined in over-extended banks more effectively than LAW because it allowed Federal Reserve Banks to use price discrimination when lending to highly leveraged counterparties. The perverse effects of the rate hike in some areas ensued because LAW lifted a pre-existing credit supply friction by incentivizing regulatory arbitrage. My results highlight the importance of context, design and financial infrastructure for the effectiveness of financial stability policies.

JEL Classification: E44, E51, E52, E58, G21, N12, N22

Suggested Citation

Rieder, Kilian, Financial Stability Policies and Bank Lending: Quasi-Experimental Evidence from Federal Reserve Interventions in 1920-21 (December, 2020). ESRB: Working Paper Series 2020/113, Available at SSRN: https://ssrn.com/abstract=3742259 or http://dx.doi.org/10.2139/ssrn.3742259

Kilian Rieder (Contact Author)

Oesterreichische Nationalbank (Eurosystem) ( email )

Otto-Wagner-Platz 3, PO Box 61
Vienna,
1010 Vienna, A-1011
Austria

HOME PAGE: http://kilianrieder.com/

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