Does Easing Monetary Policy Increase Financial Instability?

Ambrogio Cesa-Bianchi, Alessandro Rebucci

NBER Working Paper No. 22283
Issued in May 2016
NBER Program(s):International Finance and Macroeconomics, Monetary Economics

This paper develops a model featuring both a macroeconomic and a financial friction that speaks to the interaction between monetary and macro-prudential policy and to the role of U.S. monetary and regulatory policy in the run up to the Great Recession. There are two main results. First, real interest rate rigidities in a monopolistic banking system increase the probability of a financial crisis (relative to the case of flexible interest rate) in response to contractionary shocks to the economy, while they act as automatic macro-prudential stabilizers in response to expansionary shocks. Second, when the interest rate is the only available policy instrument, a monetary authority subject to the same constraints as private agents cannot always achieve a (constrained) efficient allocation and faces a trade-off between macroeconomic and financial stability in response to contractionary shocks. An implication of our analysis is that the weak link in the U.S. policy framework in the run up to the Global Recession was not excessively lax monetary policy after 2002, but rather the absence of an effective second policy instrument aimed at preserving financial stability.

download in pdf format
   (838 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w22283

Published: Cesa-Bianchi, Ambrogio & Rebucci, Alessandro, 2017. "Does easing monetary policy increase financial instability?," Journal of Financial Stability, Elsevier, vol. 30(C), pages 111-125. citation courtesy of

Users who downloaded this paper also downloaded* these:
Schmitt-Grohé and Uribe w22264 Multiple Equilibria in Open Economy Models with Collateral Constraints: Overborrowing Revisited
Woodford w22285 Quantitative Easing and Financial Stability
Chang and Velasco w21955 Financial Frictions and Unconventional Monetary Policy in Emerging Economies
Goldin w22445 How Japan and the US Can Reduce the Stress of Aging
Dávila and Korinek w22444 Pecuniary Externalities in Economies with Financial Frictions
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us