Monetary Policy, the Financial Cycle and Ultra-low Interest Rates
Do the prevailing unusually and persistently low real interest rates reflect a decline in the natural rate of interest as commonly thought? We argue that this is only part of the story. The critical role of financial factors in influencing medium-term economic fluctuations must also be taken into account. Doing so for the United States yields estimates of the natural rate that are higher and, at least since 2000, decline by less. As a result, policy rates have been persistently and systematically below this measure. Moreover, we find that monetary policy, through the financial cycle, has a long-lasting impact on output and, by implication, on real interest rates. Therefore, a narrative that attributes the decline in real rates primarily to an exogenous fall in the natural rate is incomplete. The influence of monetary and financial factors should not be ignored. Exploiting these results, an illustrative counterfactual experiment suggests that a monetary policy rule that takes financial developments systematically into account during both good and bad times could help dampen the financial cycle, leading to higher output even in the long run.
Consequences of Bank Loan Growth: Evidence from Asia
When an increase in bank loans does not immediately lead to a hike in non-performing loans, bank loan officers (and/or bank managers) whose compensation is based on the value/amount of loans granted have incentives to grant more loans to (potentially lower credit quality) borrowers, which should increase the banks’ profits (and their personal compensation) in the short run. Using a sample of publicly listed banks in 18 countries in Asia during the period 1990-2014, I show that banks’ loan growth rate has a negative short-run effect on their nonperforming loans and a positive short-run effect on their profitability. While the loan growth rate does not increase non-performing loans in the short run, there is some evidence to suggest that it increases non-performing loans in the long run. The results further indicate that banks’ profitability is not affected by the level of loans but by the loan growth rate.