Working Paper: NBER ID: w22283
Authors: Ambrogio Cesabianchi; Alessandro Rebucci
Abstract: This paper develops a model featuring both a macroeconomic and a financial friction that speaks to the interaction between monetary and macro-prudential policy and to the role of U.S. monetary and regulatory policy in the run up to the Great Recession. There are two main results. First, real interest rate rigidities in a monopolistic banking system increase the probability of a financial crisis (relative to the case of flexible interest rate) in response to contractionary shocks to the economy, while they act as automatic macro-prudential stabilizers in response to expansionary shocks. Second, when the interest rate is the only available policy instrument, a monetary authority subject to the same constraints as private agents cannot always achieve a (constrained) efficient allocation and faces a trade-off between macroeconomic and financial stability in response to contractionary shocks. An implication of our analysis is that the weak link in the U.S. policy framework in the run up to the Global Recession was not excessively lax monetary policy after 2002, but rather the absence of an effective second policy instrument aimed at preserving financial stability.
Keywords: monetary policy; financial instability; macroprudential policy
JEL Codes: E44; E52; E58; E65
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| real interest rate rigidities (E43) | probability of a financial crisis (G01) |
| probability of a financial crisis (G01) | financial stability (G28) |
| real interest rate rigidities (E43) | macroprudential stabilizers (E63) |
| one policy instrument (E61) | constrained efficient allocation (D61) |
| one policy instrument (E61) | tradeoff between macroeconomic and financial stability (E60) |
| monetary policy stance + stronger regulatory measures (E63) | more effective monetary policy (E52) |