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The Risks of Low Interest Rates

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  • Leonardo Gambacorta

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Abstract

At present, monetary policy in major advanced economies is highly accommodative; policy rates are close to zero and unconventional monetary measures have been sharply expanded. However, the recovery remains fragile and the policy discussion has shifted from exit timing to the possible distortions that a prolonged period of low interest rates may cause. In addressing the latter issue, this paper examines how far an exceptionally easy monetary policy may have unintended consequences for financial stability. The main channels by which monetary policy may influence risk-taking have been widely investigated (Borio and Zhu, 2008). There is, however, less evidence for the possible medium to long-term consequences of prolonged periods of policy rates close to zero and the extensive use of balance sheet policies (Borio and Disyatat, 2009; Del Negro, Ferrero and Kiyotaki, 2010). This paper suggests four possible ways by which a prolonged period of low interest rates could create distortions, by: a) inducing "evergreening policies" and postponing necessary adjustment in banks’ balance sheets; b) making bank profitability particularly vulnerable to future increases in interest rates; c) distorting the allocation of savings and the functioning of financial markets and d) influencing capital flows to emerging markets and creating pressure on exchange rates.

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Article provided by BANCO DE LA REPÚBLICA - ESPE in its journal ENSAYOS SOBRE POLÍTICA ECONÓMICA.

Volume (Year): (2011)
Issue (Month): ()
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Handle: RePEc:col:000107:009440

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Keywords: Monetary Policy; Risks; Interest Rates;

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  1. Nobuhiro Kiyotaki & Gauti Eggertsson & Andrea Ferrero & Marco Del Negro, 2010. "The Great Escape? A Quantitative Evaluation of the Fed’s Non-Standard Policies," 2010 Meeting Papers 113, Society for Economic Dynamics.
  2. Anonymous, 0. "Economic Development And Aid," Increasing Understanding of Public Problems and Policies, Farm Foundation.
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