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Monetary policy hysteresis and the financial cycle

Author

Listed:
  • Phurichai Rungcharoenkitkul
  • Claudio Borio
  • Piti Disyatat Author-X-Name_First: Piti

Abstract

A long tradition of macroeconomic analysis accords monetary policy only a transient role in driving real outcomes. At the same time, a large body of evidence highlights the long-lasting impact of boom-bust cycles. We present a model where monetary policy, through its impact on and reaction to the financial cycle, influences long-term economic trajectories. The core setup is an overlapping generations model featuring bank financing – the creation of bank loans and inside money – which is critical for production and consumption. Monetary policy attains the first-best allocation by sustaining an efficient flow of financing. We then introduce coordination-failure frictions among lenders, which give rise to an endogenous boom-bust cycle in bank financing and an intertemporal policy tradeoff. A forward-looking policymaker optimally leans against excessive risk-taking during the boom, trading off short-term activity with longer-term stability. An inordinate focus on short-term outcomes can lead to `monetary policy hysteresis', where low interest rates increase the vulnerability to financial busts over successive cycles. As a result, low rates can beget lower rates.

Suggested Citation

  • Phurichai Rungcharoenkitkul & Claudio Borio & Piti Disyatat Author-X-Name_First: Piti, 2019. "Monetary policy hysteresis and the financial cycle," BIS Working Papers 817, Bank for International Settlements.
  • Handle: RePEc:bis:biswps:817
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    References listed on IDEAS

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    Cited by:

    1. Kumhof, Michael & Rungcharoenkitkul, Phurichai & Sokol, Andrej, 2020. "How Does International Capital Flow?," CEPR Discussion Papers 15526, C.E.P.R. Discussion Papers.
    2. Claudio Borio & Piti Disyatat & Phurichai Rungcharoenkitkul, 2018. "What anchors for the natural rate of interest?," PIER Discussion Papers 98, Puey Ungphakorn Institute for Economic Research, revised Nov 2018.
    3. Thomas Mayer & Gunther Schnabl, 2019. "Reasons for the Demise of Interest: Savings Glut and Secular Stagnation or Central Bank Policy?," CESifo Working Paper Series 7954, CESifo.
    4. Piti Disyatat, 2019. "Comments on "The global impact of risk-off shocks"," BIS Papers chapters, in: Bank for International Settlements (ed.), Asia-Pacific fixed income markets: evolving structure, participation and pricing, volume 102, pages 25-28, Bank for International Settlements.
    5. Claudio Borio, 2019. "On money, debt, trust and central banking," BIS Working Papers 763, Bank for International Settlements.
    6. Claudio Borio, 2019. "Central banking in challenging times," BIS Working Papers 829, Bank for International Settlements.

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    More about this item

    Keywords

    monetary policy; financial cycle; money neutrality; hysteresis; natural rate of interest; intertemporal tradeoff;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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