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Unformatted text preview: is desirable to reduce
how frequently such crises occur. The role that monetary policy can or should play in
this regard remains controversial. However, a crisis that sharply reduces intermediary
capital can more easily occur, in the sense that the size of the required exogenous
disturbance is smaller, when intermediaries are highly leveraged. Thus, while the
increased volume of lending that a relaxation of leverage constraints makes possible 17 Note that on this analysis, the effects of targeted central bank asset purchases have nothing to do with
“quantitative easing,” as the effects do not depend on the purchases being financed by an increase in
bank reserves, nor do conditions in the market for bank reserves play any role in our analysis. See Cúrdia
and Woodford (2010b) for further discussion. 42 Journal of Economic Perspectives can
can improve the short-run allocation of resources, this benefit must be weighed against
the increased risk of occurrence of a crisis that will (if it occurs) increase distortions in
the future, in ways that monetary policy will not then be able to counteract fully.
The model sketched here implies that increased leverage in the financial secto...
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