Monetary and Macroprudential Policies in a Leveraged Economy

Abstract

We examine the optimal monetary policy in the presence of endogenous feedback loops between asset prices and economic activity when macroprudential policies can also be pursued. Absent macroprudential policies, the optimal monetary policy leans against asset prices and can be closely approximated, using a speed‐limit rule that responds to the growth of financial variables. An endogenous feedback loop is crucial for this result: price stability is otherwise quasi‐optimal. Similarly, a simple macroprudential rule that links reserve requirements to credit growth dampens the endogenous feedback loop and leads to near price stability. State‐contingent taxes on lending are shown to be welfare‐improving.

Bank Capital in the Short and in the Long Run

“…Our work is connected to the literature on the interaction between monetary and macroprudential policy in stabilizing fluctuations (e.g. De Paoli and Paustian, 2013; Kiley and Sim, 2017;Lambertini et al 2013;Leduc and Natal, 2016;Collard et al, 2017;Carrillo et al 2017;Gersbach el al., 2018;Ferrero et al, 2018;Van der Ghote, 2018). Differently from these studies, we focus on the interaction of policies during the transition to higher capital requirements in a framework where the capital requirements reduce bank default.…”

Bank capital in the short and in the long run

“…Our work is connected to the literature on the interaction between monetary and macroprudential policy in stabilizing fluctuations (e.g. De Paoli and Paustian, 2013; Kiley and Sim, 2017;Lambertini et al 2013;Leduc and Natal, 2016;Collard et al, 2017;Carrillo et al 2017;Gersbach el al., 2018;Ferrero et al, 2018;Van der Ghote, 2018). Differently from these studies, we focus on the interaction of policies during the transition to higher capital requirements in a framework where the capital requirements reduce bank default.…”

Financial constraints, risk sharing, and optimal monetary policy

“…By characterizing optimal monetary policy in the presence of financial frictions, this paper is related to Bean et al (2010), Andrés et al (2013), Cúrdia and Woodford (2016), Farhi and Werning (2016), Collard et al (2017), De Paoli and Paustian (2017), Ferrero et al (2018), Leduc and Natal (2018), and Van der Ghote (2021). The closest set-ups to the current paper are in Andrés et al (2013) and Ferrero et al (2018), who also allow for consumer type heterogeneity, collateral constraints, and financial intermediation.…”