Abstract
AbstractThis paper addresses the question of whether and how easy monetary policy may lead to excesses in financial and real asset markets and ultimately result in financial dislocation. It presents evidence suggesting that periods when short-term interest rates were persistently and significantly below what Taylor rules would prescribe are correlated with increases in asset prices, especially as regards housing, though no systematic effects are identified on equity markets. Significant asset price increases, however, can also occur when interest rates are in line with Taylor rules, possibly associated with periods of financial deregulation and/or innovation. Finding also some support for a link of countries’ pre-crisis monetary stance with the extent to which their financial sectors were hit during the recent crisis, the paper argues that accommodating monetary policy over the period 2002–2005, probably in combination with rapid financial market innovation, would, in retrospect, seem to have been among the factors behind the run-up in asset prices and financial imbalances—the (partial) unwinding of which helped trigger the recent financial market crisis.
Highlights
Introduction and Main FindingsThis paper addresses the question of whether monetary policy ease may lead to excesses in financial and real asset markets and result in financial dislocation
The evidence suggests that periods when short-term interest rates were persistently and significantly below what Taylor rules would have prescribed tended to coincide with increases in asset prices, especially as regards housing
Significant asset price increases have occurred when interest rates were in line with Taylor rules, probably associated with periods of financial deregulation and/or innovation, which may often give a strong boost to economic activity by themselves and thereby may lead simple Taylor rules to be overly conservative
Summary
This paper addresses the question of whether monetary policy ease may lead to excesses in financial and real asset markets and result in financial dislocation. Significant asset price increases have occurred when interest rates were in line with Taylor rules, probably associated with periods of financial deregulation and/or innovation, which may often give a strong boost to economic activity by themselves and thereby may lead simple Taylor rules to be overly conservative. Monetary policy was accommodating over the period 2002–2005, and possibly in combination with rapid financial market innovation, would, in retrospect, seem to have been among the factors behind the run-up in asset prices and financial imbalances—the unwinding of which helped trigger the recent financial market crisis. The paper is structured in the following way: Section one assesses monetary conditions of twenty-one OECD countries in recent decades, examining how far interest rates may have diverged from Taylor rule levels. Section two focuses on developments in housing markets, and section three synthesises the features of recent and historic episodes of monetary ease
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