"Interest rate trap", or: Why does the central bank keep the policy rate too low for too long time?
AbstractThis paper provides a framework for modeling the risk-taking channel of monetary policy, the mechanism how financial intermediaries’ incentives for liquidity transformation are affected by the central bank’s reaction to financial crisis. Anticipating central bank’s reaction to liquidity stress gives banks incentives to invest in excessive liquidity transformation, triggering an "interest rate trap" - the economy will remain stuck in a long lasting period of sub-optimal,low interest rate equilibrium. We demonstrate that interest rate policy as financial stabilizer is dynamically inconsistent, and the constraint efficient outcome can be implemented by imposing ex ante liquidity requirements.
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Bibliographic InfoPaper provided by Norges Bank in its series Working Paper with number 2011/12.
Length: 26 pages
Date of creation: 21 Nov 2011
Date of revision:
Interest rate trap; Risk-taking channel; Systemic risk; Liquidity requirements; Macroprudential regulation;
Other versions of this item:
- Jin Cao & Gerhard Illing, 2012. ""Interest Rate Trap", or: Why Does the Central Bank Keep the Policy Rate too Low for too Long Time?," CESifo Working Paper Series 3794, CESifo Group Munich.
- E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Douglas W. Diamond & Raghuram G. Rajan, 2012.
"Illiquid Banks, Financial Stability, and Interest Rate Policy,"
Journal of Political Economy,
University of Chicago Press, vol. 120(3), pages 552 - 591.
- Douglas W. Diamond & Raghuram Rajan, 2011. "Illiquid Banks, Financial Stability, and Interest Rate Policy," NBER Working Papers 16994, National Bureau of Economic Research, Inc.
- Francesco Giavazzi & Alberto Giovannini, 2010.
"Central Banks and the Financial System,"
NBER Working Papers
16228, National Bureau of Economic Research, Inc.
- Lukas Scheffknecht, 2013. "Contextualizing Systemic Risk," ROME Working Papers 201317, ROME Network.
- Jin Cao & Lorán Chollete, 2013. "Central Banking and Financial Stability in the Long Run," CESifo Working Paper Series 4272, CESifo Group Munich.
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