Economist Thorsten Beck posting at the World Bank CrisisTalk Blog:
The loose monetary policy in the first years of the 21st century has been one of the culprits for the boom and subsequent bust in the U.S., but rigorously testing this hypothesis is difficult .. But perhaps we can learn something from a small open economy for which monetary policy decisions can be considered exogenous. A recent paper by Vasso Ioannidou, Steven Ongena and Jose Luis Peydro does exactly this, using a unique dataset on Bolivian borrowers. During the period 1999 to 2003, the local currency was pegged to the U.S. dollar and the relevant short-term benchmark rate was the U.S. federal funds rate. The paper shows that reductions in short-term interest rates do indeed lead to excessive risk taking by banks, which can eventually lead to banking fragility when interest rates rise back to “normal” levels.