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Reaching for Yield and the Diabolic Loop in a Monetary Union

Boubaker, S.; Gounopoulos, D.; Nguyen, D.K.; Paltalidis, N.

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Authors

S. Boubaker

D. Gounopoulos

D.K. Nguyen



Abstract

We use the theoretical framework of Acharya and Naqvi (2019) to introduce a macro-financial model where the “reaching for yield” incentivized by a loosening monetary policy in the United States mitigates the diabolic loop in a Monetary Union. We provide empirical evidence that the introduction of an accommodative monetary policy by the Fed lowers the yields in US assets and increases liquidity and, by extension, the threshold above which a liquidity shock can damage a bank. This, in turn, incentivizes bank managers to optimize their portfolios by investing in risky assets. We use a monetary VAR to provide novel empirical evidence that there is an increase in the flow of funds to European assets, a result which can be attributed to the “reaching-for-yield” incentive. This portfolio balance channel attenuates the effects of financial fragility and improves government funding costs as well as credit conditions by providing liquidity to domestic banks and assets. As a result, the “reaching-for-yield” incentive mitigates the diabolic loop effect.

Citation

Boubaker, S., Gounopoulos, D., Nguyen, D., & Paltalidis, N. (2020). Reaching for Yield and the Diabolic Loop in a Monetary Union. Journal of International Money and Finance, 108, Article 102157. https://doi.org/10.1016/j.jimonfin.2020.102157

Journal Article Type Article
Acceptance Date Jan 29, 2020
Online Publication Date Feb 11, 2020
Publication Date 2020-11
Deposit Date Feb 1, 2020
Publicly Available Date Aug 11, 2021
Journal Journal of International Money and Finance
Print ISSN 0261-5606
Publisher Elsevier
Peer Reviewed Peer Reviewed
Volume 108
Article Number 102157
DOI https://doi.org/10.1016/j.jimonfin.2020.102157
Public URL https://durham-repository.worktribe.com/output/1278300

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