Series: Working Papers. 1805.
Author: Angela Abbate and Dominik Thaler.
Published in: Journal of Money, Credit and Banking. Volume 51, Issue 8, December 2019, Pages 2115-2144
Full document
Abstract
How important is the risk-taking channel for monetary policy? To answer this question, we develop and estimate a quantitative monetary DSGE model where banks choose excessively risky investments, due to an agency problem which distorts banks’ incentives. As the real interest rate declines, these distortions become more important and excessive risk taking increases, lowering the efficiency of investment. We show that this novel transmission channel generates a new and quantitatively significant monetary policy trade-off between inflation and real interest rate stabilization: it is optimal for the central bank to tolerate greater inflation volatility in exchange for lower risk taking.