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Financial Stability and Monetary Policy – A Framework

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  • Gerhard Illing

Abstract

The paper presents a stylised framework to analyse conditions under which monetary policy contributes to amplified movements in the housing market. Extending work by Hyun Shin (2005), the paper analyses self enforcing feedback mechanisms resulting in amplifier effects in a credit constrained economy. The paper characterizes conditions for asymmetric effects, causing systemic crises. By injecting liquidity, monetary policy can prevent a meltdown. Anticipating such a response, private agents are encouraged to take higher risks. Provision of liquidity works as a public good, but it may create potential conflicts with other policy objectives and may give incentives to build up leverage with a high systemic exposure to small probability events.

Suggested Citation

  • Gerhard Illing, 2007. "Financial Stability and Monetary Policy – A Framework," CESifo Working Paper Series 1971, CESifo.
    • Handle: RePEc:ces:ceswps:_1971
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    File URL: https://www.cesifo.org/DocDL/cesifo1_wp1971.pdf
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    References listed on IDEAS

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    7. Upper, Christian & Worms, Andreas, 2004. "Estimating bilateral exposures in the German interbank market: Is there a danger of contagion?," European Economic Review, Elsevier, vol. 48(4), pages 827-849, August.
    8. Sauer, Stephan, 2007. "Liquidity Risk and Monetary Policy," Discussion Papers in Economics 2012, University of Munich, Department of Economics.
    9. Milgrom, Paul & Roberts, John, 1994. "Comparing Equilibria," American Economic Review, American Economic Association, vol. 84(3), pages 441-459, June.
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    Cited by:

    1. Castillo, Paul & Vega, Hugo & Serrano, Enrique & Burga, Carlos, 2016. "De-dollarization of credit in Peru: the role of unconventional monetary policy tools," Working Papers 2016-002, Banco Central de Reserva del Perú.
    2. Adão, Luiz F.S. & Silveira, Douglas & Ely, Regis A. & Cajueiro, Daniel O., 2022. "The impacts of interest rates on banks’ loan portfolio risk-taking," Journal of Economic Dynamics and Control, Elsevier, vol. 144(C).

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