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Title:"Interest Rate Trap", or: Why does the central bank keep the policy rate too low for too long time? PDF Logo
Authors:Cao, Jin
Illing, Gerhard
Issue Date:2012
Series/Report no.:CESifo working paper: Monetary Policy and International Finance 3794
Abstract:This paper provides a framework for modeling the risk-taking channel of monetary policy, the mechanism how financial intermediaries’ incentives for liquidity transformation are affected by the central bank’s reaction to financial crisis. Anticipating central bank’s reaction to liquidity stress gives banks incentives to invest in excessive liquidity transformation, triggering an 'interest rate trap' - the economy will remain stuck in a long lasting period of sub-optimal, low interest rate equilibrium. We demonstrate that interest rate policy as financial stabilizer is dynamically inconsistent, and the constraint efficient outcome can be implemented by imposing ex ante liquidity requirements.
Subjects:interest rate trap
risk-taking channel
systemic risk
liquidity requirements
macroprudential regulation
JEL:E50
G21
G28
Document Type:Working Paper
Appears in Collections:CESifo Working Papers, CESifo Group Munich

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