Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/171950
Authors: 
Bauer, Gregory H.
Granziera, Eleonora
Year of Publication: 
2016
Series/Report no.: 
Bank of Canada Staff Working Paper 2016-59
Abstract: 
Can monetary policy be used to promote financial stability? We answer this question by estimating the impact of a monetary policy shock on private-sector leverage and the likelihood of a financial crisis. Impulse responses obtained from a panel VAR model of 18 advanced countries suggest that the debt-to-GDP ratio rises in the short run following an unexpected tightening in monetary policy. As a consequence, the likelihood of a financial crisis increases, as estimated from a panel logit regression. However, in the long run, output recovers and higher borrowing costs discourage new lending, leading to a deleveraging of the private sector. A lower debt-to-GDP ratio in turn reduces the likelihood of a financial crisis. These results suggest that monetary policy can achieve a less risky financial system in the long run but could fuel financial instability in the short run. We also find that the ultimate effects of a monetary policy tightening on the probability of a financial crisis depend on the leverage of the private sector: the higher the initial value of the debt-to-GDP ratio, the more beneficial the monetary policy intervention in the long run, but the more destabilizing in the short run.
Subjects: 
Monetary policy
Financial stability
Credit and credit aggregates
Transmission of monetary policy
JEL: 
E52
E58
C21
C23
Document Type: 
Working Paper

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