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We would like to thank Gabriele Galati, Sweder van Wijnbergen, Luc Laeven, Enrico Perotti, Nicola Viegi, Steven Ongena, Claudio Borio, Refet Gurkaynak, Andrew Hughes Hallett, Markus Brunnermeier, Marvin Goodfriend, David Miles, Lars Svensson, Wolf Wagner, Neeltje van Horen, Vincent Sterk, John Lewis, Andrew Filardo, Dam Lammertjan and Olivier Pierrard for discussions, Erlend Nier, Machiko Narita and Deniz Igan for written comments, and audiences at the IMF, the BIS, the ECB, the Fed Board, the Boston Fed, the Bank of England, the Bank of Japan, the Bank of Korea, the Hong Kong Monetary Authority / BIS Office HK, DNB, and various conferences for their comments. All remaining errors are our own.
De Nederlandsche Bank and European Commission.
This is found by Altunbas, Gambacorta and Marquez-Ibanez (2010, 2014), Delis and Brissimis (2010), Maddaloni and Peydró (2011, 2013), Delis and Kouretas (2011), Delis, Hasan and Mylonidis (2011), Paligorova and Santos (2012), Geršl et al. (2012), Dell’Ariccia, Laeven and Suarez (2013), Buch, Eickmeier and Prieto (2014a,b), Jiménez et al. (2014), Ioannidou, Ongena and Peydró (2015) and Morais, Peydró and Ruiz (2015). Monetary policy may also induce risk taking in the non-bank sector (Feroli et al., 2014; Hanson and Stein, 2015; Chen et al., 2015; Galí and Gambetti, 2015; Cecchetti, Mancini-Griffoli, and Narita, 2015). See also the discussions in Bayoumi et al. (2014), Smets (2014), Diaz Kalan et al. (2015), and IMF (2015).
The economic significance of this effect is confirmed in the empirical work on monetary policy and leverage of Adrian and Shin (2009, 2010), Adrian, Moench and Shin (2010), Bruno and Shin (2015), and Angeloni, Faia and Lo Duca (2015).
Nonetheless, even absent bank risk choice there can be interaction between monetary policy and bank regulation: bank capitalization affects loan rates, and thus interacts with monetary transmission. See, for instance, De Walque, Pierrard and Rouabah (2010), Darracq Pariès, Kok Sørensen and Rodriguez-Palenzuela (2011), Kannan, Rabanal and Scott (2012), and Agénor, Alper and Pereira da Silva (2013). Financial wealth can provide an alternative route to generate macrofinancial linkages (Vitek, 2013).
Alternative approaches include non-linear modelling (Brunnermeier and Sannikov, 2014; Ajello et al, 2015) and general equilibrium models that are not dynamic and stochastic (Goodhart et al., 2013; Cesa-Bianchi and Rebucci, 2015).
If we accept that monetary policy should include a financial stability objective along its traditional objectives of inflation and output stabilization, then we can show that the timing of optimal monetary policy changes, as we do in the companion paper Agur and Demertzis (2013). In response to a negative demand shock, rate cuts become both deeper and shorter-lived, as the monetary authority aims to mitigate the buildup of bank risk caused by protracted low rates.