Discussion of “The Risk Channel of Monetary Policy”

The term “risk channel of monetary policy” refers to the link between monetary policy and risk-taking behavior (Borio and Zhu 2012). According to this channel, changes in current or future central bank policies can cause changes in the perception of risk, which could lead to changes in economic activity through rebalancing of portfolio composition. For example, a central bank reaction function that is more accommodative to a recession ex post can lead households, firms, and financial institutions to take larger leverage positions ex ante, as they perceive the recession to be less severe. In turn, the endogenous adjustment in balance sheet positions can affect the transmission of monetary policy. The key goal of this paper is to quantitatively assess the risk channel of monetary policy. To do so, it constructs a DSGE model with a banking sector with debt and equity financing and nominal rigidities, building on the work of Gertler and Karadi (2011) and Gertler, Kiyotaki, and Queralto (2012). The model is used to analyze how changes in the volatility of fundamental and monetary shocks affect the composition of the balance sheet as well as the volatility in the business cycle. Moreover, the author also investigates the effects of different interest rate rules on the riskiness of the financial sector. There are three ways in which the risk channel operates in the model. First, due to nominal rigidities, lowering the nominal interest rate reduces the real rate and reduces the cost of bank borrowing. Second, lowering the real interest rate increases the present value of cash flows of banks’ assets, increasing their equity value and allowing them to borrow more. Third, even keeping current or future rates