Monetary policy, private debt and financial stability risks / by Gregory H. Bauer and Eleonora Granziera. : FB3-5/2016-59E-PDF

"Can monetary policy be used to promote financial stability? We answer this question byestimating the impact of a monetary policy shock on private-sector leverage and thelikelihood of a financial crisis. Impulse responses obtained from a panel VAR model of18 advanced countries suggest that the debt-to-GDP ratio rises in the short run followingan unexpected tightening in monetary policy. As a consequence, the likelihood of afinancial crisis increases, as estimated from a panel logit regression. However, in the longrun, output recovers and higher borrowing costs discourage new lending, leading to adeleveraging of the private sector. A lower debt-to-GDP ratio in turn reduces thelikelihood of a financial crisis. These results suggest that monetary policy can achieve aless risky financial system in the long run but could fuel financial instability in the shortrun. We also find that the ultimate effects of a monetary policy tightening on theprobability of a financial crisis depend on the leverage of the private sector: the higherthe initial value of the debt-to-GDP ratio, the more beneficial the monetary policyintervention in the long run, but the more destabilizing in the short run"--Abstract, p. ii.

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