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Monetary policy, financial conditions, and financial stability

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Abstract

We review a growing literature that incorporates endogenous risk premiums and risk taking in the conduct of monetary policy. Accommodative policy can create an intertemporal trade-off between improving current financial conditions and increasing future financial vulnerabilities. In the United States, structural and cyclical macroprudential tools to reduce vulnerabilities at banks are being implemented, but they may not be sufficient because activities can migrate and there are limited tools for nonbank intermediaries and for borrowers. While monetary policy itself can influence vulnerabilities, its efficacy as a tool will depend on the costs of tighter policy on activity and inflation. We highlight that adding a risk-taking channel to traditional transmission channels could significantly alter a cost-benefit calculation for using monetary policy, and that considering risks to financial stability?as downside risks to employment?is consistent with the dual mandate..

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  • Tobias Adrian & J. Nellie Liang, 2014. "Monetary policy, financial conditions, and financial stability," Staff Reports 690, Federal Reserve Bank of New York.
  • Handle: RePEc:fip:fednsr:690
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    Keywords

    risk-taking channel of monetary policy; monetary policy transmission; monetary policy rules; financial stability; financial conditions; macroprudential policy; leaning against the wind;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G01 - Financial Economics - - General - - - Financial Crises
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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