Working Paper: CEPR ID: DP16490
Authors: Kilian Rieder
Abstract: This paper exploits a natural experiment to provide the first empirical analysis on the comparative effects of the two principal families of modern financial stability policy. In 1920, four U.S. Federal Reserve Banks leaned against the wind by raising their interest rate indiscriminately for all banks to safeguard financial stability. Another four Federal Reserve Banks employed targeted policy action instead, requiring only over-extended banks to pay higher interest rates. To identify the policies' comparative treatment effects, I leverage newly digitized micro data and draw on geographic border discontinuities across districts with different policy choices. Fixing time and environment, I find that targeted policy leads to a significant reduction in lending, a more even distribution of credit and central bank borrowing across banks, higher bank survival rates, and improved local economic outcomes relative to the conventional interest rate hike.
Keywords: monetary policy; macroprudential policy; leaning against the wind; credit boom; bank lending; leverage; federal reserve system; progressive discount rate; recession of 1920-1921
JEL Codes: E52; E58; N12; N22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Uniform interest rate hike (E43) | bank lending (G21) |
| Targeted monetary policy (PDR) (E52) | bank lending (G21) |
| Targeted monetary policy (PDR) (E52) | over-leveraged banks (G21) |
| Uniform interest rate hike (E43) | risk-shifting behavior (D91) |
| Uniform interest rate hike (E43) | bank lending (New York) (G21) |