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Monetary easing and financial instability

Acharya, Viral and Plantin, Guillaume (2017) Monetary easing and financial instability. SRC Discussion Paper, No. 63. Systemic Risk Centre, The London School of Economics and Political Science, London, UK.

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Identification Number: No. 63

Abstract

We study optimal monetary policy in the presence of financial stability concerns. We build a model in which monetary easing can lower the cost of capital for firms and restore the natural level of investment, but does also subsidize inefficient maturity transformation by financial intermediaries in the form of “carry trades" that borrow cheap at the short-term against illiquid long-term assets. Carry trades not only lead to financial instability in the form of rollover risk, but also crowd out real investment since intermediaries equate the marginal return on lending to firms to that on carry trades. Optimal monetary policy trades off any stimulative gains against these costs of carry trades. The model provides a framework to understand the puzzling phenomenon that the unprecedented post-2008 monetary easing has been associated with below-trend real investment, even while returns to real and financial capital have been historically high.

Item Type: Monograph (Discussion Paper)
Official URL: http://www.systemicrisk.ac.uk/
Additional Information: © 2016 The Authors
Subjects: H Social Sciences > HB Economic Theory
H Social Sciences > HG Finance
JEL classification: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy (Targets, Instruments, and Effects)
E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies
G - Financial Economics > G0 - General > G00 - General
G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
G - Financial Economics > G2 - Financial Institutions and Services > G23 - Pension Funds; Other Private Financial Institutions
G - Financial Economics > G2 - Financial Institutions and Services > G28 - Government Policy and Regulation
Sets: Research centres and groups > Systemic Risk Centre
Date Deposited: 24 Mar 2017 15:25
Last Modified: 24 Mar 2017 15:25
Projects: ES/K002309/1
Funders: Economic and Social Research Council
URI: http://eprints.lse.ac.uk/id/eprint/70715

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