Template-type: ReDIF-Paper 1.0
Author-Name: Dr. Angela Abbate
Author-Name-First: Angela
Author-Name-Last: Abbate
Author-Person: pab300
Author-Name: Dominik Thaler
Author-Name-First: Dominik
Author-Name-Last: Thaler
Author-Person: pth316
Title: Optimal monetary policy with the risk-taking channel
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).
Length: 53 pages
Creation-Date: 2021
Contact-Email: forschung@snb.ch
File-URL: https://www.snb.ch/en/publications/research/working-papers/2021/working_paper_2021_09
File-Format: text/html
Number: 2021-09
Classification-JEL: E44, E52
Keywords: Risk-taking channel, optimal monetary policy
Handle: RePEc:snb:snbwpa:2021-09