The aim of this paper is to study the interaction between monetary policy and prudential regulation in an agent-based modeling framework. Several relevant policy implications are drawn from this analysis. First, the implementation of a cyclical capital component as proposed in Basel III loses its efficacy when combined with some interest rate rules. Second, interest rate smoothing is more effective than the other interest rate rules assessed, as it outperforms them concerning financial stability and performs as well as them regarding macroeconomic stability. Finally, there is no long-run tradeoff between macroeconomic and financial stability regarding the assessed parameters. Resumo: O objetivo deste trabalho é estudar a interação entre política monetária e regulação prudencial em um modelo baseado em agentes. Várias implicações relevantes relativas a política econômica emergem desta análise. Primeiro, a implementação de um componente cíclico de capital, tal como proposto em Basileia III, perde sua eficácia quando combinado com algumas regras de taxas de juros. Segundo, o smoothing da taxa de juros mostrou-se mais efetivo que outras regras de taxas de juros, já que supera as mesmas relativamente a estabilidade financeira e é tão eficaz quanto as demais no que tange a estabilidade macroeconômica. Finalmente, não há um trade-off entre estabilidade macroeconômica e financeira relativamente aos parâmetros avaliados.
We open the black box of the monetary policy transmission mechanism with a granular model that considers the balance-sheet composition and network relationships of each economic agent. Though there are several well-documented channels through which monetary policy operates, we focus on the overlooked trading book channel, which arises because of adjustments in the accounting value of trading book exposures on banks’ balance sheets that have to be marked to market when interest rates change. Variations in banks’ net worth due these adjustments are used as input to a network model that incorporates the financial and corporate sectors. The framework permits us to determine the effects of interest rate changes on every bank and firm in the economy and any second-round (contagion) effects in the short run. We apply the model to a comprehensive database of Brazilian banks and firms from 2015 to 2020. We find that interest rate shocks affect more strongly financial stability in periods of monetary policy tightening. We also find notable asymmetric effects of positive and negative interest rate shocks in the Brazilian economy, with positive interest rate shocks affecting more financial stability. Finally, our results also suggest a non-linear relationship between interest rate changes and financial stability, reinforcing the need to mitigate monetary policy shocks through interest rate smoothing and adequate communication and transparency to society.
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