Template-Type: ReDIF-Paper 1.0
Author-Name: Phurichai Rungcharoenkitkul
Author-X-Name-First: Phurichai 
Author-X-Name-Last: Rungcharoenkitkul
Author-Name: Claudio Borio 
Author-X-Name-First: Claudio 
Author-X-Name-Last: Borio 
Author-Name: Piti Disyatat
Author-X-Name_First: Piti 
Author-X-Name-Last: Disyatat
Title: Monetary policy hysteresis and the financial cycle
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.
Length: 50 pages
Creation-Date: 2019-10
File-URL: https://www.bis.org/publ/work817.pdf
File-Format: Application/pdf
File-Function: Full PDF document
File-URL: https://www.bis.org/publ/work817.htm
File-Format: text/html
Number: 817
Classification-JEL: E52, E58, E43
Keywords: monetary policy, financial cycle, money neutrality, hysteresis, natural rate of interest, intertemporal tradeoff
Handle: RePEc:bis:biswps:817