by Fabio Verona,a,b Manuel M. F. Martins,b and Inês Drumondb,c
Motivated by the U.S. events of the 2000s, we address whether a too low for too long interest rate policy may generate a boom-bust cycle. We simulate anticipated and unanticipated monetary policies in state-of-the-art DSGE models and in a model with bond financing via a shadow banking system, in which the bond spread is calibrated for normal and optimistic times. Our results suggest that the U.S. boom-bust was caused by the combination of (i) too low for too long interest rates, (ii) excessive optimism, and (iii) a failure of agents to anticipate the extent of the abnormally favorable conditions.
JEL Codes: E32, E44, E52, G24.
Full article (PDF, 46 pages 1529 kb)
a Bank of Finland
b University of Porto, CEF.UP
c DG-ECFIN, European Commission