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Collateralized Borrowing and Risk Taking at Low Interest Rates?

A view advanced in the aftermath of the late-2000s fi?nancial crisis is that lower than optimal interest rates lead to excessive risk taking by fi?nancial intermediaries. We evaluate this view in a quantitative dynamic model where interest rate policy affects risk taking through two channels. First, policy influences the attractiveness of safe bond investments relative to riskier assets. Moreover, policy changes the amount of safe bonds available for collateralized borrowing in interbank markets. In this framework, collateral constraints provide a safeguard against increases in risk taking. Lower than optimal policy rates lead to tighter collateral constraints and reduce risk taking.

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Paper provided by University of Western Ontario, Economic Policy Research Institute in its series University of Western Ontario, Economic Policy Research Institute Working Papers with number 20121.

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Date of creation: 2012
Date of revision:
Handle: RePEc:uwo:epuwoc:20121
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Economic Policy Research Institute, Social Science Centre, University of Western Ontario, London, Ontario, Canada N6A 5C2

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