Interest Rates, Venture Capital, and Financial Stability

Authors

Hilary J. Allen, American University Washington College of LawFollow

Document Type

Article

Publication Date

7-13-2023

Abstract

Following several prominent bank failures and as central banks continue to tighten interest rates to fight inflation, there is increasing interest in the relationship between monetary policy and financial stability. This Article illuminates one path through which the prolonged period of low interest rates from 2009-2021 has impacted financial stability: it traces how yield-seeking behavior in the wake of the Global Financial Crisis and Covid pandemic led to a bubble in the venture capital industry, which in turn spawned a crypto bubble as well as a run on the VC-favored Silicon Valley Bank. This Article uses this narrative to illustrate the importance of proactive financial regulation both in preventing financial crises that invite more accommodative monetary policy, and in preventing accommodative monetary policy from sowing the seeds of future financial stability problems if it is deployed.

The Article is primarily a descriptive account, designed to highlight the venture capital industry’s unexpected and underappreciated contribution to financial stability threats in the early 2020s. This Article does, however, suggest several policy implications of this account. It argues for increased monitoring of the venture capital industry by financial stability regulators, given that venture capital is well-positioned to generate asset bubbles now and in the future. More specifically, it argues for more aggressive enforcement of the securities laws to tamp down on the present crypto bubble, as well as for structural separation between crypto and the traditional financial system.

Recommended Citation

Hilary J. Allen, Interest Rates, Venture Capital, and Financial Stability, (2023).
Available at: https://digitalcommons.wcl.american.edu/facsch_lawrev/2229