Central Banks and the Financial System
AbstractFinancial systems are inherently fragile because of the very function which makes them valuable: liquidity transformation. Thus regulatory reforms, as urgent and desirable as they are, will definitely strengthen the financial system and decrease the risk of liquidity crises, but they will never eliminate it. This leaves monetary policy with a very important task. In a framework that recognizes the interactions between monetary policy and liquidity transformation 'optimal' monetary policy would consist of a modified Taylor rule in which the real rate reflects the possibility of liquidity crises and recognizes the possibility that liquidity transformation gets ubsidized. Failure to recognize this point risks leading the economy into a low interest rate trap: low interest rates induce too much risk taking and increase the probability of crises. These crises, in turn, require low interest rates to maintain the ?nancial system alive. Raising rates becomes extremely difficult in a severely weakened financial system, so monetary authorities remain stuck in a low interest rates trap. This seems a reasonable description of the situation we have experienced throughout the past decade.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 425.
Date of creation: 2011
Date of revision:
Contact details of provider:
Postal: via Rontgen, 1 - 20136 Milano (Italy)
Web page: http://www.igier.unibocconi.it/
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-01-03 (All new papers)
- NEP-CBA-2012-01-03 (Central Banking)
- NEP-MAC-2012-01-03 (Macroeconomics)
- NEP-MON-2012-01-03 (Monetary Economics)
You can help add them by filling out this form.
reading list or among the top items on IDEAS.Access and download statisticsgeneral information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.