"Low for Long" and Risk-Taking

The COVID-19 pandemic is causing an unprecedented worldwide economic contraction, leading central banks to reduce interest rates to historically low levels and making unconventional monetary policies—including “low for long” interest rates and asset purchases—increasingly common. Arguably, however, the policies implemented are efficient because they encourage increased risk-taking, and they may have, if unintentionally, increase medium- and long-run macro-financial vulnerabilities. This paper argues that the resulting trade-offs need to be carefully accounted for in monetary policy models and outlines how that can be achieved in practice.