U.S. monetary policy shocks induce comovements in the international financial variables that characterize the “Global Financial Cycle.” A single global factor that explains an important share of the variation of risky asset prices around the world decreases significantly after a U.S. monetary tightening. Monetary contractions in the US lead to significant deleveraging of global financial intermediaries, a decline in the provision of domestic credit globally, strong retrenchments of international credit flows, and tightening of foreign financial conditions. Countries with floating exchange rate regimes are subject to similar financial spillovers.

We develop a dynamic macroeconomic model with heterogeneous financial intermediaries and endogenous entry. Time-varying endogenous macroeconomic risk arises from the risk-shifting behaviour of the cross-section of financial intermediaries. When interest rates are high, a decrease in interest rates stimulates investment and decreases aggregate risk. In contrast, when they are low, further stimulus can increase financial instability while inducing a fall in the risk premium. In this case, there is a trade-off between stimulating the economy and financial stability. This provides a model of the risk-taking channel of monetary policy.