Monetary Policy Inertia, Macroprudential Policy, and Financial Stability in a Liquidity Trap

Purpose The global financial crisis demonstrated that monetary policy alone cannot ensure both price and financial stability. According to the Tinbergen (1952) rule, there was a gap in the policymakers’ toolkit for safeguarding financial stability, as the number of available policy instruments was insufficient relative to the number of policy objectives. That gap is now being closed through the creation of new macroprudential policy instruments. Both monetary policy and macroprudential policy have the capacity to influence both price and financial stability objectives. This paper develops a framework for determining how best to assign instruments to objectives. Design/methodology/approach Using a simplified New-Keynesian model, the authors examine two sets of policy trade-offs, the first concerning the relative effectiveness of monetary and macroprudential policy instruments in achieving price and financial stability objectives and the second concerning trade-offs between macroprudential policy instruments themselves. Findings This model shows that regardless of whether the objective is to enhance financial system resilience or to moderate the financial cycle, macroprudential policies are more effective than monetary policy. Likewise, monetary policy is more effective than macroprudential policy in achieving price stability. According to the Mundell (1962) principle of effective market classification, this implies that macroprudential policy instruments should be paired with financial stability objectives, and monetary policy instruments should be paired with the price stability objective. The authors also find a trade-off between the two sets of macroprudential policy instruments, which indicates that failure to moderate the financial cycle would require greater financial system resilience. Originality/value The main contribution of the paper is to establish – with the help of a model framework – the relative effectiveness of monetary and macroprudential policies in achieving price and financial stability objectives. By so doing, it provides a rationale for macroprudential policy and it shows how macroprudential policy can unburden monetary policy in leaning against the wind of financial imbalances.

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Monetary Policy, Macroprudential Policy, and Financial Stability

Annual Review of Economics ◽

10.1146/annurev-economics-080218-025625 ◽

2019 ◽

Vol 11 (1) ◽

pp. 809-832 ◽

Cited By ~ 1

Author(s):

David Martinez-Miera ◽

Rafael Repullo

Keyword(s):

Monetary Policy ◽

Equilibrium Model ◽

Financial Stability ◽

Theoretical Perspective ◽

Capital Requirements ◽

Equity Capital ◽

Open Market ◽

Macroprudential Policy ◽

Macroprudential Policies

This review reexamines from a theoretical perspective the role of monetary and macroprudential policies in addressing the build-up of risks in the financial system. We construct a stylized general equilibrium model in which the key friction comes from a moral hazard problem in firms’ financing that banks’ equity capital serves to ameliorate. Tight monetary policy is introduced by open market sales of government debt, and tight macroprudential policy by an increase in capital requirements. We show that both policies are useful, but macroprudential policy is more effective in fostering financial stability and leads to higher social welfare.

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Macroprudential Policy: Resolution and Continued Challenges

International Journal of Financial Research ◽

10.5430/ijfr.v9n4p43 ◽

2018 ◽

Vol 9 (4) ◽

pp. 43

Author(s):

Igor M Tomic ◽

John Angelidis

Keyword(s):

Monetary Policy ◽

Financial Stability ◽

Stress Tests ◽

Financial Industry ◽

Macroprudential Policy ◽

Policy Responses ◽

Macroprudential Policies ◽

Lehman Brothers ◽

Financial Firm ◽

Lengthy Process

In this paper we address three issues; 1) The importance of knowing the exact damage caused by a failing firm, as that knowledge assists in creating more efficient policy responses. The failure of a large and complex financial firm, Lehman Brothers, experienced a very difficult and lengthy process in its resolution; the damage was much greater than expected, leading to a change in policies and specifically to a requirement for stress tests; 2) Macroprudential policies are very helpful as the can address issues in a specific sector, something that monetary policy is not designed for. This means that monetary policy designed to bring output and price stability, when combined with macroprudential tools, provides more financial stability; 3) Although macroprudential policies have stabilized the financial industry, some threats remain and therefore several threats are explored.

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The Interaction of Monetary and Macroprudential Policies - Background Paper

Policy Papers ◽

10.5089/9781498339513.007 ◽

2012 ◽

Vol 2012 (106) ◽

Cited By ~ 15

Author(s):

Keyword(s):

Monetary Policy ◽

Side Effects ◽

Financial Stability ◽

Interactive Effects ◽

Price Stability ◽

Macroprudential Policy ◽

Macroprudential Policies ◽

Background Material

This paper provides background material to support the Board paper on the interaction of monetary and macroprudential policies. It analyzes the scope for and evidence on interactions between monetary and macroprudential policies. It first reviews a recent conceptual literature on interactive effects that arise when both macroprudential and monetary policy are employed. It goes on to explore the “side effects” of monetary policy on financial stability and their implications for macroprudential policy. It finally addresses the strength of possible effects of macroprudential policies on output and price stability, and draws out implications for the conduct of monetary policy.

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Monetary and macroprudential policy under global financial cycle: The experience of small open economies

Voprosy Ekonomiki ◽

10.32609/0042-8736-2021-6-5-31 ◽

2021 ◽

pp. 5-31

Author(s):

R. R. Akhmetov ◽

M. E. Mamonov ◽

V. A. Pankova

Keyword(s):

Monetary Policy ◽

Interest Rates ◽

Financial Stability ◽

Global Financial Crisis ◽

Open Economies ◽

Small Open Economies ◽

Negative Consequences ◽

Macroprudential Policy ◽

Financial Cycle ◽

The Impact

This review examines the impact of the global financial cycle on small open economies and compares the effectiveness of various monetary and macroprudential policies in the presence of global financial cycle. First, we provide a classification of the channels through which the monetary policy of the world financial regulators (US Federal Reserve, ECB), which largely determines the global financial cycle, is transmitted to small open economies: the channel for interest rates differential, the channel for the activities of global financial institutions, and the channel for commodity prices. Second, by analyzing the arguments of supporters and critics of the monetary policy trilemma, we show how the literature comes to the conclusion that inflation targeting policy is still one of the most optimal solutions for achieving the goals of price and macroeconomic stability but fails to ensure financial stability. The latter requires active coordination with macroprudential policy measures. These conclusions are supported by the analysis of case studies of specific countries (Russia, New Zealand, Brazil, Turkey, etc.), which attempted to mitigate negative consequences of the 2007—2009 global financial crisis.

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Monetary Policy, Macroprudential Policy, and Financial Stability

SSRN Electronic Journal ◽

10.2139/ssrn.3427096 ◽

2019 ◽

Author(s):

David Martinez-Miera ◽

Rafael Repullo

Keyword(s):

Monetary Policy ◽

Financial Stability ◽

Macroprudential Policy

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Financial Stability and Sustainability under the Coordination of Monetary Policy and Macroprudential Policy: New Evidence from China

Sustainability ◽

10.3390/su11061616 ◽

2019 ◽

Vol 11 (6) ◽

pp. 1616 ◽

Cited By ~ 4

Author(s):

Ying Jiang ◽

Chong Li ◽

Jizhou Zhang ◽

Xiaoyi Zhou

Keyword(s):

Monetary Policy ◽

Risk Taking ◽

Financial Stability ◽

Stock Price ◽

Generalized Method Of Moments ◽

Housing Prices ◽

Policy Coordination ◽

Macroprudential Policy ◽

Price Bubbles ◽

Coordination Effect

After the financial crisis, financial stability and sustainability became key to global economic and social development, and the coordination of monetary policy and macroprudential policy plays a crucial role in maintaining financial stability and sustainability. This paper provides a theoretical analysis and empirical evidence from China on the impact of monetary policy and macroprudential policy coordination on financial stability and sustainability. We collect data from 2003 to 2017; from the micro level, we use the System Generalized Method of Moments (System GMM) method to analyze the monetary policy and macroprudential policy coordination effect on 88 commercial banks’ risk-taking; from the macro level, we use the Structural Vector Autoregression (SVAR) method to analyze the two policies coordination effect on housing prices and stock price bubbles. The conclusions are as follows: firstly, for regulating bank risk-taking, monetary policy and macroprudential policy should conduct counter-cyclical regulation simultaneously; secondly, for regulating housing prices, tight monetary policy and tight macroprudential policy should be implemented alternately; thirdly, for regulating stock price bubbles, macroprudential policy should be the first line of defense and monetary policy should be the second one.

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Out of Sync Subnational Housing Markets and Macroprudential Policies in the UK

De Economist ◽

10.1007/s10645-021-09394-1 ◽

2021 ◽

Author(s):

Michael Funke ◽

Petar Mihaylovski ◽

Adrian Wende

Keyword(s):

Monetary Policy ◽

Financial Stability ◽

Housing Stock ◽

House Prices ◽

House Price ◽

Housing Markets ◽

Macroprudential Policy ◽

Macroprudential Policies ◽

The Uk ◽

Price Differences

AbstractWe examine whether regionally differentiated macroprudential policies can address financial stability concerns and moderate house price differences in the UK. We disaggregate both the household sector and the housing stock in a two-region DSGE model with out of sync subnational housing markets and compare four policy types: standard monetary policy, leaning against the wind monetary policy, national macroprudential policy or one that targets region-specific LTV ratios. In terms of reducing variances of house prices, regionally differentiated macroprudential policy performs best, provided the policy authorities are concerned with stabilising output and house prices rather than simply minimising the variance of inflation.

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Macroprudential Policy Instruments of Central Banks

Voprosy Ekonomiki ◽

10.32609/0042-8736-2012-8-32-47 ◽

2012 ◽

pp. 32-47

Author(s):

S. Andryushin ◽

V. Kuznetsova

Keyword(s):

Systemic Risk ◽

Financial Stability ◽

Financial System ◽

Policy Instruments ◽

Central Banks ◽

Macroprudential Policy ◽

Policy Studies ◽

The Future ◽

Financial Cycles

The paper analyzes central banks macroprudencial policy and its instruments. The issues of their classification, option, design and adjustment are connected with financial stability of overall financial system and its specific institutions. The macroprudencial instruments effectiveness is evaluated from the two points: how they mitigate temporal and intersectoral systemic risk development (market, credit, and operational). The future macroprudentional policy studies directions are noted to identify the instruments, which can be used to limit the financial systemdevelopment procyclicality, mitigate the credit and financial cycles volatility.

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