Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/278343 
Year of Publication: 
2023
Series/Report no.: 
ECB Working Paper No. 2772
Publisher: 
European Central Bank (ECB), Frankfurt a. M.
Abstract: 
Empirical research suggests that lower interest rates induce banks to take higher risks. We assess analytically what this risk-taking channel implies for optimal monetary policy in a tractable New Keynesian model. We show that this channel creates a motive for the planner to stabilize the real rate. This objective conflicts with the standard inflation stabilization objective. Optimal policy thus tolerates more inflation volatility. An inertial Taylor-type reaction function becomes optimal. We then quantify the significance of the risk-taking channel for monetary policy in an estimated medium-scale extension of the model. Ignoring the channel when designing policy entails non-negligible welfare costs (0.7% lifetime consumption equivalent).
Subjects: 
Risk-taking channel
Optimal monetary policy
Inertial policy rate
JEL: 
E44
E52
Persistent Identifier of the first edition: 
ISBN: 
978-92-899-5514-0
Document Type: 
Working Paper

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