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Federal Reserve Bank of San Francisco
FRBSF Economic Letter
Monetary Policy Cycles and Financial Stability
Pascal Paul
Abstract

Recent research suggests that sustained accommodative monetary policy has the potential to increase financial instability. However, under some circumstances tighter monetary policy may increase financial fragility through two channels. First, a surprise tightening tends to reduce the market value of banks’ equity and raise their market leverage, exacerbating balance sheet fragility in the short run. Second, increases in the federal funds rate have historically been followed by an expansion of assets held by money market funds, which proved to be a source of instability in the 2007-09 financial crisis.


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Pascal Paul, "Monetary Policy Cycles and Financial Stability" , Federal Reserve Bank of San Francisco, FRBSF Economic Letter, number 06, 2018.
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