Report

The Financial (In)Stability Real Interest Rate, R**


Abstract: We introduce the concept of a financial stability real interest rate using a macroeconomic banking model with an occasionally binding financing constraint, as in Gertler and Kiyotaki (2010). The financial stability interest rate, r**, is the threshold interest rate that triggers the constraint being binding. Increasing imbalances in the financial sector, measured by an increase in leverage, are accompanied by a lower threshold that could trigger financial instability events. We also construct a theoretical implied financial conditions index and show how it is related to the gap between the natural and financial stability interest rates.

Keywords: r**; financial crises; financial stability; occasionally binding credit constraint;

JEL Classification: E4; E5; G0;

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Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2020-11-01

Number: 946