Working Paper: NBER ID: w11728
Authors: Raghuram G. Rajan
Abstract: Developments in the financial sector have led to an expansion in its ability to spread risks. The increase in the risk bearing capacity of economies, as well as in actual risk taking, has led to a range of financial transactions that hitherto were not possible, and has created much greater access to finance for firms and households. On net, this has made the world much better off. Concurrently, however, we have also seen the emergence of a whole range of intermediaries, whose size and appetite for risk may expand over the cycle. Not only can these intermediaries accentuate real fluctuations, they can also leave themselves exposed to certain small probability risks that their own collective behavior makes more likely. As a result, under some conditions, economies may be more exposed to financial-sector-induced turmoil than in the past. The paper discusses the implications for monetary policy and prudential supervision. In particular, it suggests market-friendly policies that would reduce the incentive of intermediary managers to take excessive risk.
Keywords: No keywords provided
JEL Codes: G0; G1; G2; G3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial Development (O16) | Increased Risk-Bearing Capacity (F65) |
| Financial Development (O16) | Increased Risk-Taking by Intermediaries (G21) |
| Increased Risk-Taking by Intermediaries (G21) | Greater Systemic Risk (E44) |
| Financial Development (O16) | Increased Exposure to Financial Turmoil (F65) |
| Incentives of Intermediary Managers (M12) | Riskier Behavior (D91) |
| Low Interest Rates (E43) | Increased Risk-Taking by Intermediaries (G21) |