Global financial integration and the linkages between the financial and the real sides of economies are sources of huge policy challenges. This is now beyond doubt, after what we saw in the run-up to and the unfolding of the 2008 global financial crisis. As a consequence, the established wisdom regarding monetary policies and prudential regulation has been subject to a deep critical review, including a demise of the belief that they should be maintained as fully independent functions.
Monetary policy is widely considered as an effective tool for short-term stabilization. However, in recent decades, evidence suggests that its effectiveness in the US has been somewhat dampened. What is the reason behind this trend? Can it inform us about the relationship between monetary policy transmission and the complexity of the financial system?
In a recent paper, Alessandro Barattieri, Dalibor Stevanovic, and I document a rising trend in the fraction of financial claims which have direct counterparts in the financial sector (rather than the non-financial sector, which includes traditional borrowers such as firms, households and governments). We estimate that, up until the 1970s, close to 100% of financial assets had direct non-financial counterparts; today these traditional claims represent a mere 70% of financial assets, while the rest represent loans between financial institutions. We point out that this trend roughly coincides with the declining impact of monetary policy shocks, and propose a model that links these two trends.
- monetary policy