Capital Flows and the Risk-Taking Channel of Monetary Policy

Working Papers No 400
December 2012

This paper examines the relationship between low interests maintained by advanced economy central banks and credit booms in emerging economies. In a model with crossborder banking, low funding rates increase credit supply, but the initial shock is amplified through the "risk-taking channel" of monetary policy where greater risk-taking interacts with dampened measured risks that are driven by currency appreciation to create a feedback loop. In an empirical investigation using VAR analysis, we find that expectations of lower short-term rates dampen measured risks and stimulate cross-border banking sector capital flows.

JEL classification: F32, F33, F34

Keywords: Capital flows, exchange rate appreciation, credit booms