Working Paper: CEPR ID: DP17896
Authors: Maximilian Grimm; Oscar Jorda; Moritz Schularick; Alan M. Taylor
Abstract: Do periods of persistently loose monetary policy increase financial fragility and the likelihood of a financial crisis? This is a central question for policymakers, yet the literature does not provide systematic empirical evidence about this link at the aggregate level. In this paper we fill this gap by analyzing long-run historical data. We find that when the stance of monetary policy is accommodative over an extended period, the likelihood of financial turmoil down the road increases considerably. We investigate the causal pathways that lead to this result and argue that credit creation and asset price overheating are important intermediating channels.
Keywords: financial crises; crisis prediction; monetary policy; natural rate
JEL Codes: E43; E44; E52; E58; G01; G21; N10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| stance of monetary policy (E63) | likelihood of financial crises (G01) |
| loose monetary policy (E52) | likelihood of financial crises (G01) |
| loose monetary policy (E52) | credit creation (E51) |
| loose monetary policy (E52) | asset price overheating (G19) |
| credit creation (E51) | likelihood of financial crises (G01) |
| asset price overheating (G19) | likelihood of financial crises (G01) |