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Interest Rates, Leverage, and Money

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Abstract

The current mainstream approach to monetary policy is based on the New Keynesian model and is expressed in terms of a short-term nominal interest, such as the federal funds rate in the United States. It ignores the role of leverage and also downplays the role of money in basic monetary theory and monetary policy analysis. But as the federal funds rate has reached the zero lower bound and the Federal Reserve is in a liquidity trap, the issue is whether there is a useful role of leverage and monetary aggregates in monetary policy and business cycle analysis. We address these issues and argue that there is a need for financial stability policies to manage the leverage cycle and reduce the procyclicality of the financial system. We also argue that in the aftermath of the global financial crisis and Great Contraction there is a need to get away from the New Keynesian thinking and back toward a quantity theory approach to monetary policy, based on properly measured monetary aggregates, such as the new Center for Financial Stability Divisia monetary aggregates.

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Authors and Affiliations

  1. Department of Economics, University of Calgary, Calgary, AB T2N 1N4, Canada

    Apostolos Serletis & Khandokar Istiak

  2. Department of International Economic Relations and Development, Democritus University of Thrace, Komotini, Greece

    Periklis Gogas

Authors
  1. Apostolos Serletis
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  2. Khandokar Istiak
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  3. Periklis Gogas
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Correspondence to Apostolos Serletis.

Additional information

This paper was presented at the 16th International Conference on Macroeconomic Analysis and International Finance held on May 24–26, 2012 in the University Campus, Rethymno, Greece.

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Serletis, A., Istiak, K. & Gogas, P. Interest Rates, Leverage, and Money. Open Econ Rev 24, 51–78 (2013). https://doi.org/10.1007/s11079-012-9253-5

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