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Monetary easing, lack of investment and financial instability

Author

Listed:
  • Acharya, Viral V.
  • Plantin, Guillaume
  • Reggiani, Pietro
  • Yao, Iris

Abstract

Low monetary policy rates lower the cost of capital for firms, thereby spurring productive investment. Low interest rates however can also induce the private sector to enter into risky carry trades when they imply that the earned carry more than offsets liquidity risk. Such carry trades and productive investment compete for funds, so much so that the former may crowd out the latter. Below an endogenous lower bound, monetary easing generates only limited capital expenditures that come at the cost of large and destabilizing financial risk-taking. Absent the ability to regulate carry trades, monetary easing must be complemented with a restrictive emergency-lending policy in the form of higher lending rates so as to discourage risk-taking by relatively illiquid firms. Monetary easing, tepid investment response, and rollover risk for liquid firms then arise jointly (and optimally) in equilibrium.

Suggested Citation

  • Acharya, Viral V. & Plantin, Guillaume & Reggiani, Pietro & Yao, Iris, 2024. "Monetary easing, lack of investment and financial instability," Journal of Financial Intermediation, Elsevier, vol. 59(C).
    • Handle: RePEc:eee:jfinin:v:59:y:2024:i:c:s1042957324000287
    DOI: 10.1016/j.jfi.2024.101100
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    More about this item

    Keywords

    Monetary policy; Emergency lending; Financial stability; Financial fragility; Shadow banking; Carry trades; Rollover risk;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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