American University
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Capital flows and the risk-taking channel of monetary policy

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posted on 2023-08-05, 10:42 authored by Valentina BrunoValentina Bruno, Hyun Song Shin

This paper examines the relationship between low interests maintained by advanced economy central banks and credit booms in emerging economies. In a model with crossborder banking, low funding rates increase credit supply, but the initial shock is amplified through the “risk-taking channel” of monetary policy where greater risk-taking interact with dampened measured risks that are driven by currency appreciation to create a feedback loop. In an empirical investigation using VAR analysis, we find that expectations of lower short-term rates dampens measured risks and stimulate cross-border banking sector capital flows.



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