Low-interest rate, macroprudential policies stabilise financial market

by Krizzel Canlas12 Sep 2017

The low interest-rate environment and tighter macroprudential policies can stabilise financial markets, according to the latest research from the Reserve Bank.

In their discussion paper, Fang Yao and Margarita Rubio, argued that in a low interest-rate environment the case for using macroprudential policies, aimed at ensuring a more stable financial system, becomes even stronger. 

They also said that when interest rates are persistently low, agents tend to engage in speculative investment in assets, such as real estate.

Therefore, Yao and Rubio said, low interest rates may also contribute to asset price bubbles and excessive leverage which pose risks to financial stability.

Greater financial volatility due to low interest rates calls for macroprudential policies to contain excessive bank lending, Yao and Rubio said.

According to the authors, an economic model was used for policy evaluation that takes into account nominal interest rates subject to a zero, lower bound and cannot become negative.

“We calibrate the model to characteristics of the US economy where the Federal funds rate has been close to zero for 7 years,” the authors said.

“Within this setting, we find that when the interest rate is persistently low, activity in the financial markets and the wider economy becomes more volatile.

"Therefore, we propose macroprudential policy as a candidate to stabilise the economy in this context.”

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