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Do Low Interest Rates Sow the Seeds of Financial Crises?

Author

Listed:
  • Simona E. Cociuba
  • Malik Shukayev
  • Alexander Ueberfeldt

Abstract

A view advanced in the aftermath of the late-2000s financial crisis is that lower than optimal interest rates lead to excessive risk taking by financial intermediaries. We evaluate this view in a quantitative dynamic model in which interest rate policy affects risk taking by changing the amount of safe bonds that intermediaries use as collateral in the repo market. In this model with properly-priced collateral, lower than optimal interest rates reduce risk taking. We also consider the possibility that intermediaries can augment their collateral by issuing assets whose risk is underestimated by credit rating agencies, as was observed prior to the crisis. In the presence of such mispriced collateral, lower than optimal interest rates contribute to excessive risk taking and amplify the severity of recessions.

Suggested Citation

  • Simona E. Cociuba & Malik Shukayev & Alexander Ueberfeldt, 2011. "Do Low Interest Rates Sow the Seeds of Financial Crises?," Staff Working Papers 11-31, Bank of Canada.
  • Handle: RePEc:bca:bocawp:11-31
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    References listed on IDEAS

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    Cited by:

    1. Manthos D. Delis & Iftekhar Hasan & Nikolaos Mylonidis, 2017. "The Risk‐Taking Channel of Monetary Policy in the U.S.: Evidence from Corporate Loan Data," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 49(1), pages 187-213, February.
    2. Sami Alpanda & Gino Cateau & Cesaire Meh, 2014. "A policy model to analyze macroprudential regulations and monetary policy," BIS Working Papers 461, Bank for International Settlements.
    3. Ekin Ayşe Özşuca & Elif Akbostancı, 2016. "An Empirical Analysis of the Risk-Taking Channel of Monetary Policy in Turkey," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 52(3), pages 589-609, March.
    4. Corbae, Dean & D'Erasmo, Pablo, 2014. "Capital requirements in a quantitative model of banking industry dynamics," Working Papers 14-13, Federal Reserve Bank of Philadelphia.
    5. repec:mes:emfitr:v:52:y:2016:i:3:p:589-609 is not listed on IDEAS
    6. Ekin Ayse Ozsuca & Elif Akbostanci, 2012. "An Empirical Analysis of the Risk Taking Channel of Monetary Policy in Turkey," ERC Working Papers 1208, ERC - Economic Research Center, Middle East Technical University, revised Dec 2012.
    7. Oleksiy Kryvtsov & Miguel Molico & Ben Tomlin, 2015. "On the Nexus of Monetary Policy and Financial Stability: Recent Developments and Research," Discussion Papers 15-7, Bank of Canada.

    More about this item

    Keywords

    Transmission of monetary policy; Financial system regulation and policies;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets

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