At the end of last year, dr Christiaan van der Kwaak, dr Tom Boot and dr Björn Mitzinneck received a Veni grant from the Dutch Research Council ( NWO ) worth up to €250,000. The grants provide the laureates with the opportunity to further develop their own research projects during a period of three years. The VENI grants are aimed at excellent researchers who have recently obtained their doctorate. Christiaan van der Kwaak introduces himselfs and tells more about his research.

“I received a masters in Theoretical Physics from the University of Groningen in 2010, followed by a Research Master in Economics at the Tinbergen Institute in 2012. Afterwards, I obtained my PhD from the University of Amsterdam, having had the opportunity to work with Sweder van Wijnbergen. I started a tenure track in monetary economics at the University of Groningen in the summer of 2016.

My Veni research

I will investigate how unconventional monetary policies affect financial stability, and whether these types of policies can actually increase the probability of new financial crises. Unconventional monetary policies have been employed since the Great Financial Crisis of 2007-2009, when central banks had to resort to these policies when short-term nominal interest rates (the main instrument of conventional monetary policy) could not be lowered any further. Examples of unconventional monetary policies are forward guidance, negative interest rates, long-term lending to commercial banks, and asset purchase programmes, under which government bonds, for example, are bought by the European Central Bank (ECB). Several of these policies have been in place for many years.

Both the theoretical as well as the empirical academic literature find that unconventional monetary policies have positive short-run effects on credit provision to firms, investment and economic growth. The reason is that these policies decrease long-term interest rates, which makes it more attractive for firms to borrow. The additional funds that are borrowed are then used for new investments that ultimately increase the size of the economy (Gertler and Karadi, 2011).

Commercial banks and other financial institutions typically make a profit because of a `credit spread’ between the long-term interest rate at which they lend to the real economy, and the short-term interest rate at which they borrow from savers. Unconventional monetary policies, however, decrease long-term interest rates without decreasing short-term interest rates. As a result, the credit spread decreases, leading to lower profits for commercial banks and other financial intermediaries.

In such an environment, commercial banks can increase their profitability in two ways. First, they can increase leverage, i.e. the fraction of their balance sheet that is financed through debt. Second, commercial banks can lend to riskier borrowers or invest in riskier projects, which allows them to charge a higher interest rate as compensation for the additional risks they face. While both ways increase commercial banks’ profitability, they also increase the likelihood of bankruptcy in the future. As a result, financial crises become more likely.

In my Veni research I am going to construct a general equilibrium model that features both the positive short-run effects of unconventional monetary policies, as well as the possibility for banks to choose the amount of risk with which they operate. Therefore, I will be able to investigate the extent to which unconventional monetary policies may increase risk taking by banks, and to what extent they might sow the seeds of future financial crises. My model will be able to simulate existing unconventional monetary policies run by the ECB, and tell whether future financial crises have become more likely as a result.

Societal relevance

Some central bankers have been very well aware of the risks that unconventional monetary policies might pose for financial stability: both Dutch Central Bank (DNB) president Klaas Knot as well as the Bundesbank president, Jens Weidmann, have repeatedly warned for excessive risk-taking in financial markets as a result of the unconventional monetary policies employed by the ECB. Most general equilibrium models do not incorporate these financial stability risks, which makes it hard for central bankers to quantify to what extent their policies are contributing to financial instability. My model, however, will be able to do so.

Therefore, my research has direct relevance, as the models that I aim to construct could be employed by central bankers to shed light on the financial stability risks of the ECB’s unconventional monetary policies. The attractive feature of employing general equilibrium models, such as the one that I will work with in this research, is that they are capable of evaluating alternative or counterfactual policies and scenarios. For example, the ECB could use my model to evaluate a policy in which they rely less on purchasing government bonds, and more on providing the banking system with cheap loans.

As a result, my research has the potential to improve decision-making at central banks.”

Key publications

Van der Kwaak, C.G.F., S.J.G. van Wijnbergen (2017), “Sovereign Debt and Bank Fragility in Spain”, Review of World Economics, 153 (3), 511-543.

Van der Kwaak, C.G.F., S.J.G. van Wijnbergen (2014), “Financial Fragility, Sovereign Default Risk and the Limits to Commercial Bank Bail-outs”, Journal of Economic Dynamics and Control, 43, 218-240.

Van der Kwaak, C. (2020). Unintended Consequences of Central Bank Lending in Financial Crises. (SOM Research Reports; Vol. 2020011-EEF). University of Groningen, SOM research school.