Loose Monetary Policy and Financial Instability

Author(s): Maximilian Grimm, Oscar Jorda, Moritz Schularick, and Alan M. Taylor

Do periods of persistently loose monetary policy increase financial fragility and the likelihood of a financial crisis? This is a central question for policymakers, yet the literature does not provide systematic empirical evidence about this link at the aggregate level. In this paper we fill this gap by analyzing long run historical data. We find that when the stance of monetary policy is accommodative over an extended period, the likelihood of financial turmoil down the road increases considerably. We investigate the causal pathways that lead to this result and argue that credit creation and asset price overheating are important intermediating channels.

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Article Citation

Grimm, Maximilian, Oscar Jorda, Moritz Schularick, and Alan M. Taylor. 2023. "Loose Monetary Policy and Financial Instability," Federal Reserve Bank of San Francisco Working Paper 2023-06. Available at https://doi.org/10.24148/wp2023-06