A short but sharp interest rate cut may be the best response to shocks.
As 2008 began, leverage ratios at many banks were north of 40 to 1, but financial engineering had dispersed risk, and risk models were giving executives minute-by-minute readings on the health of their institutions. Just nine months later, it was all in ruins. Banks have an interest in taking on more risk than may be prudent for society at large, and persistently low interest rates tilt the risk/reward equation dramatically. Central banks responding to economic shocks tend to be cautious when raising rates as an economy improves, thereby helping to drive bubbles. In this technical paper, economists Itai Agur and Maria Demertzis propose that central banks consider a new approach to financial stability. getAbstract suggests their innovative work to financial policy makers and to central and commercial bankers.
In this summary, you will learn
- How monetary policy affects bank risk
- What the limits of risk regulations are
- How central banks can use interest rates to ensure financial stability
About the Authors
Itai Agur is an economist at the IMF’s Singapore Regional Training Institute. Maria Demertzis, an economist at De Nederlandsche Bank, is on secondment to the European Commission.
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