Monetary Policy, Financial Conditions, and Financial Stability

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in AbstractIn the conduct of monetary policy, there exists a risk-return trade-off between financial conditions and financial stability, which complements monetary policy's traditional trade-off between inflation and real activity. The trade-off exists even if monetary policy does not target financial stability considerations independently of its inflation and real activity goals, because risks to future financial stability are increased by the buildup of financial vulnerabilities from persistent accommodative monetary policy when the economy is close to potential. We review monetary policy transmission channels and financial frictions that give rise to this trade-off between financial conditions and financial stability, within a monitoring program across asset markets, banking firms, shadow banking, and the nonfinancial sector. We focus on vulnerabilities that affect monetary policy's risk-return trade-off, including 1) pricing of risk, 2) leverage, 3) maturity and liquidity mismatch, and 4) interconnectedness and complexity. We also discuss the extent to which structural and time-varying macroprudential policies can counteract the buildup of vulnerabilities, thus mitigating monetary policy's risk-return trade-off.

Monetary policy and macroprudential policy: Rivals or teammates?

“…This supports the view that accommodative monetary policy may contribute to a build-up of financial vulnerabilities, i.e. it may boost the credit cycle (Adrian and Liang, 2014). 36 The policy combinations in Table 3 should be regarded as dominant, but not always optimal and attainable.…”

“…The transmission of monetary policy through the credit channel is widely explored in the literature. It is generally accepted that easier monetary policy leads to an expansion of credit, as lower interest rates encourage borrowing (Adrian and Liang, 2014;Peek and Rosengren, 2013). 24 For example, Angeloni et al (2003) provide evidence for the credit channel in some of the largest euro area countries during 1993-1999.…”

“…From the practical point of view, however, it will be very difficult for the monetary authority to decide, especially if the two policies are conducted by different authorities. This is due to different probabilities of failure to fulfil the two main objectives (Adrian and Liang, 2014). It is highly likely that the macroeconomic forecast will imply failure to hit the inflation target in the short-to-medium run, whereas at any given moment in time systemic risk will have the potential to materialise in the medium-to-long run only.…”

Low-For-Long Interest Rates and Banks' Interest Margins and Profitability: Cross-Country Evidence

“…While this paper does not address whether low interest rates lead to unhealthy reach for yield by banks, this has been a concern among many supervisors and policy makers, and has been a subject of research (see Adrian andLiang, 2014, andDell'Ariccia andMarquez, 2013, for literature reviews of the links between interest rates and risk taking). The negative consequences of low (for long) rates on bank profitability and capitalization are additionally important to consider as analysis has suggested that the incentives for (excessive) risk-taking depend not just on the level of interest rate but also on the capitalization and franchise value of the bank (Dell'Ariccia, Laeven and Marquez, 2014).…”

Financial Imbalances, Crisis Probability and Monetary Policy in Norway

“…3 Adrian and Liang (2016) call for a broader approach than just looking at credit when conducting cost-benefit analysis of LAW policy. Svensson (2017) also notes that an analysis of the benefits of LAW based on the impact of montary policy on credit has limitations, including limitations due to a moderate effect of monetary policy on real credit and credit to GDP.…”