Monetary Policy and Excessive Bank Risk Taking

I. Agur, M. Demertzis

Research output: Working paperDiscussion paperOther research output

Abstract

If monetary policy is to aim at financial stability, how would it change? To analyze this question, this paper develops a general-form model with endogenous bank risk profiles. Policy rates affect both bank incentives to search for yield and the cost of wholesale funding. Financial stability objectives are then shown to make a monetary authority more conservative and more aggressive. Conservative as it sets higher rates on average. And aggressive because, in reaction to negative shocks, cuts are deeper but shorter-lived than otherwise. Keeping cuts short is crucial as bank risk responds primarily to stable low rates. Within the short span, cuts then must be deep to achieve standard objectives.
Original languageEnglish
Place of PublicationTilburg
PublisherEBC
Number of pages27
Volume2010-06S
Publication statusPublished - 2010

Publication series

NameEBC Discussion Paper
Volume2010-06S

Keywords

  • Monetary policy
  • Financial stability

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