Monetary policy, private debt and financial stability risks

Arbeitspapier

Can monetary policy be used to promote financial stability? We answer this question by estimating the impact of a monetary policy shock on private-sector leverage and the likelihood of a financial crisis. Impulse responses obtained from a panel VAR model of 18 advanced countries suggest that the debt-to-GDP ratio rises in the short run following an unexpected tightening in monetary policy. As a consequence, the likelihood of a financial crisis increases, as estimated from a panel logit regression. However, in the long run, output recovers and higher borrowing costs discourage new lending, leading to a deleveraging of the private sector. A lower debt-to-GDP ratio in turn reduces the likelihood of a financial crisis. These results suggest that monetary policy can achieve a less risky financial system in the long run but could fuel financial instability in the short run. We also find that the ultimate effects of a monetary policy tightening on the probability of a financial crisis depend on the leverage of the private sector: the higher the initial value of the debt-to-GDP ratio, the more beneficial the monetary policy intervention in the long run, but the more destabilizing in the short run.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Bank of Canada Staff Working Paper ; No. 2016-59

Classification and Topics

• Classification: Wirtschaft ; Monetary Policy ; Central Banks and Their Policies ; Single Equation Models; Single Variables: Cross-Sectional Models; Spatial Models; Treatment Effect Models; Quantile Regressions ; Single Equation Models; Single Variables: Panel Data Models; Spatio-temporal Models
• Subject: Monetary policy ; Financial stability ; Credit and credit aggregates ; Transmission of monetary policy

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Bauer, Gregory H. ; Granziera, Eleonora
• Event: Veröffentlichung
• (who): Bank of Canada
• (where): Ottawa
• (when): 2016

Further information

• DOI: doi:10.34989/swp-2016-59
• Handle: http://hdl.handle.net/10419/171950
• Last update: 10.03.2025, 11:43 AM CET