The Financial (In)Stability Real Interest Rate, R*
23 Pages Posted: 14 Jun 2021
Date Written: January, 2021
We introduce the concept of financial stability real interest rate using a macroeconomic banking model with an occasionally binding financing constraint as in Gertler and Kiyotaki (2010). The financial stability interest rate, r**, is the threshold interest rate that triggers the constraint being binding. Increasing imbalances in the financial sector measured by an increase in leverage are accompanied by a lower threshold that could trigger financial instability events. We also construct a theoretical implied financial condition index and show how it is related to the gap between the natural and financial stability interest rates.
Keywords: r**, Financial crises, Financial stability, Occasionally binding credit constraint
JEL Classification: E40, E50, G00
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