OECD Economics Department Working Papers

ISSN :
1815-1973 (online)
DOI :
10.1787/18151973
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Working papers from the Economics Department of the OECD that cover the full range of the Department’s work including the economic situation, policy analysis and projections; fiscal policy, public expenditure and taxation; and structural issues including ageing, growth and productivity, migration, environment, human capital, housing, trade and investment, labour markets, regulatory reform, competition, health, and other issues.

The views expressed in these papers are those of the author(s) and do not necessarily reflect those of the OECD or of the governments of its member countries.

 

Monetary Policy, Market Excesses and Financial Turmoil You or your institution have access to this content

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Author(s):
Rudiger Ahrend1, Boris Cournède1, Robert W.R. Price1
Author Affiliations
  • 1: OECD, France

Publication Date
10 Mar 2008
Bibliographic information
No.:
597
Pages
17
DOI
10.1787/244200148201

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This paper addresses the question of whether and how monetary policy ease 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 have been 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, associated with periods of financial deregulation and/or innovation. The paper argues that accommodating monetary policy over the period 2002-2005, in combination with rapid financial market innovation, would seem in retrospect to have been among the factors behind the run-up in asset prices and consequent financial imbalances -- the (partial) unwinding of which helped trigger the 2007 financial market turmoil. Moreover, the paper points out that in certain situations policy rates may be a rather blunt tool for dealing with both the build-up and aftermath of financial imbalances, raising the question whether "macro-prudential" regulation could be useful.
Keywords:
house prices, sub-prime crisis, interest rate, financial innovation, financial markets, asset prices, Taylor rule, regulation, housing, financial imbalances, monetary policy, market turmoil
JEL Classification:
  • E44: Macroeconomics and Monetary Economics / Money and Interest Rates / Financial Markets and the Macroeconomy
  • E5: Macroeconomics and Monetary Economics / Monetary Policy, Central Banking, and the Supply of Money and Credit
  • F3: International Economics / International Finance
  • G15: Financial Economics / General Financial Markets / International Financial Markets