Discussion Paper

Financial Vulnerability and Macroeconomic Fragility

Abstract: What is the effect of a hike in interest rates on the economy? Building on recent research, we argue in this post that the answer to this question very much depends on how vulnerable the financial system is. We measure financial vulnerability using a novel concept—the financial stability interest rate r** (or “r-double-star”)—and show that, empirically, the economy is more sensitive to shocks when the gap between r** and current real rates is small or negative.

Keywords: financial crises; nonlinear dynamics; shocks; financial stability;

JEL Classification: G21; E52; G2; E51;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Liberty Street Economics

Publication Date: 2023-05-22

Number: 20230522