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U.S. Monetary Policy and the Decline in the Interest Rates (1990-2007)

Explaining the Long-term U.S. Interest Rate Decline

Interest rates in the U.S. have experienced persistent declines since the 1980s. This paper by Santiago Capraro, Carlo Panico, and Luis Daniel Torres-González explains this pattern based on the choice of the Federal Reserve to attribute high priority to financial stability. The interaction between changes in financial regulation, the transformation of "specialized" into "universal” banking, and the concern with financial instability have led the central bank to assume the role of "lender of first resort" beyond its “lender of last resort” interventions. This policy systematically provides liquidity at a low cost to financial firms.

Abstract

Interest rates in the U.S. and in other countries have experienced persistent and generalised declines since the 1980s. The main interpretations of this phenomenon ignore the role of monetary factors, such as financial and monetary policy. The essay proposes an alternative interpretation based on the choice of the Federal Reserve (FED) to conduct monetary policy by attributing high priority to financial stability. The interaction between changes in financial regulation, the transformation of "specialized" into "universal” banking, and the concern with financial instability have led the central bank to add to the role of "lender of last resort" that of "lender of first resort," which systematically provides liquidity at a low cost to financial firms. This new conduct of monetary policy has produced the downward trend in interest rates.

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