Risk-taking and Monetary Policy [pdf]
“Low for long” interest rate and other accommodative monetary policies increase risk-taking and medium- and long term macro-financial vulnerabilities. This paper aims to contribute to understanding how accommodative monetary policy have reshaped the risk perspective among the fixed-income market investors. I study the effects of People’s Bank of China’s monetary announcements on domestic corporate bond prices. Exploiting information embedded in high-frequency co-movement of financial assets prices and using a Bayesian structural vector autoregression, I deconstructed market surprises around the central bank’s announcements on Reserve Requirement Ratios into shocks to investors' beliefs about monetary policy and shocks to the beliefs about non-monetary fundamentals. Using a sample of 16,738 corporate bonds issued by 2,711 non-financial firms between 2010 and 2020, I find the monetary shocks have strong effects on bond pricing and can explain about one-fourth of the price movement around the releases. I further test the hypothesis of risk-taking, i.e., whether the effects differentiate across various credit risk groups. The result shows risky bonds outperform safer bonds following a monetary easing shock, i.e., a significant increase in appetite for risk after monetary policy becomes accommodative. More importantly, the asymmetry between the effects of monetary easing and tightening further confirms the role of accommodative monetary policy as a key driver in risk-taking. The findings raise implications for financial stability and macroprudential policy.
Boom-Bust Capital Flow Cycles (w. Graciela L. Kaminsky)
China was a major participant in international capital markets during the first episode of financial globalization, which started with the end of the Napoleonic Wars in 1815 and ended with the Great Depression in 1931. China borrowed in all the main financial capitals of the world at that time: London, Paris, Frankfurt and Berlin, and New York. Besides government borrowing, private firms residing in China borrowed in international capital markets to finance their activities, from railways construction to navigation and banking activities. This paper aims to answer the question of what triggered international capital flow bonanzas and how they ended. We examine whether capital flow bonanzas to China were fueled by international liquidity (push factors), or they were fueled by the evolution of the Chinese Economy (pull-factors). We also investigate whether these capital inflows contribute to economic growth, or they triggered financial crises.