Exploring the Connection Between Monetary Policy and Financial Crises
Examining the Link between Monetary Policy and Financial Crises
The latest research and fiscal and monetary policy speeches are discussed in the latest Hutchins Roundup, keeping readers informed on the latest thinking in these areas. This week, we discuss a paper that examines the relationship between loose monetary policy and the risk of financial crises, a study that finds pandemic-era wages increased disproportionately for low-wage workers, and another research that explores the effects of recessions on local labor markets.
Loose Monetary Policy and Financial Crises: A Complex Relationship
A new study from researchers at the University of Bonn and the University of California, Davis, examines the impact of loose monetary policy on the risk of financial crises. The study uses data from 18 countries between 1870 and 2020 and measures monetary policy stance by calculating the difference between the policy and natural interest rate over five years.
The results show that when the monetary policy stance is loose by one percentage point, the risk of a financial crisis between five and seven years out increases by 5.5 percentage points. The crisis risk between seven and nine years out increases by 15.5 percentage points. This demonstrates that accommodative monetary policy can result in credit growth and increased asset prices in the medium term, leading to financial instability.
Pandemic-Era Wages Higher for Low-Wage Workers
A new paper from researchers at the Massachusetts Institute of Technology and the University of Massachusetts examines wages during the pandemic. The study shows that wages increased disproportionately for low-wage workers during the pandemic, reversing “approximately one-quarter of the rise in 90-10 wage inequality since 1980.”
The authors argue that tight labor markets increased competition for low-wage workers, reducing employer market power and spurring relative wage growth among young non-college workers. As a result, workers under 40, those without college degrees, and those who changed jobs saw large nominal wage increases. These results suggest that tight labor markets can positively impact reducing wage inequality.
Lingering Effects of Recessions on Local Labor Markets
A new study from researchers at the W.E. Upjohn Institute for Employment Research and the Federal Reserve Bank of Philadelphia explores the lingering effects of recessions on local labor markets. The study shows that areas that suffer the most job loss during a recession have persistently lower employment and population in the post-recession period relative to other areas.
The study found that metropolitan areas that experience 10% higher job loss during a recession than other areas have 11% lower employment seven to nine years after the recession trough. Additionally, larger employment losses in a region are associated with persistently lower employment-to-population ratios and earnings per capita relative to other areas in the post-recession period.
The latest research suggests that loose monetary policy can lead to financial instability, although the relationship between the two is complex. Tight labor markets during the pandemic have led to significant wage increases for low-wage workers, reversing some of the rising inequality seen since 1980. Additionally, recessions can have long-lasting impacts on local labor markets, with areas that suffer the most job loss seeing persistently lower employment and population over the long term.
- The U.S. economy added 943,000 jobs in July, lowering the unemployment rate to 5.4%.
- U.S. Treasury yields have risen recently, with the 10-year yield approaching 1.4%.
- The Federal Reserve announced last week that it plans to begin tapering its asset purchases later this year.
The latest research highlights the complex relationship between monetary policy and financial stability, the potential benefits of tight labor markets in reducing wage inequality, and the long-term impacts of recessions on local labor markets. As the economy recovers from the pandemic, policymakers must consider these findings carefully as they make decisions that could have lasting consequences.