Optimal Monetary and Macroprudential Policies: Gains and Pitfalls in a Model of Financial Intermediation

Abstract

We estimate a quantitative general equilibrium model with nominal rigidities and financial intermediation to examine the interaction of monetary and macroprudential stabilization policies. The estimation procedure uses credit spreads to help identify the role of financial shocks amenable to stabilization via monetary or macroprudential instruments. The estimated model implies that monetary policy should not respond strongly to the credit cycle and can only partially insulate the economy from the distortionary effects of financial frictions/shocks. A counter-cyclical macroprudential instrument can enhance welfare, but faces important implementation challenges. In particular, a Ramsey planner who adjusts a leverage tax in an optimal way can largely insulate the economy from shocks to intermediation, but a simple-rule approach must be cautious not to limit credit expansions associated with efficient investment opportunities. These results demonstrate the importance of considering both optimal Ramsey policies and simpler, but more practical, approaches in an empirically grounded model. JEL Classification Code: E58, E61, and G18 * The analysis and conclusions set forth are those of the authors and do not reflect those of the Federal Reserve Board or its staff. Our analysis and presentation of results benefited from comments by workshop and conference participants at the

Unpleasant Monetarist Arithmetic: Macroprudential Edition

“…16 Third, and because of policy is consistent with most of the literature, e.g. Alpanda and Zubairy (2017), Paul (2017), Svensson (2016b), Leduc and Natal (2016), IMF (2015), Kiley and Sim (2015) and Gali's (2014). For more see Appendix A.…”

“…Second, even if this is not the case, social welfare may decline in the separation setup due to a strategic conflict between M&Ms in responding to exuberant credit shocks. In particular, we derive six main policy scenarios that can occur under some values of the underlying 2 There are a number of valuable recent contributions exploring the interactions of M&Ms, see Silvo (2016), Kiley and Sim (2015), Alpanda et al (2014), Angelini et al (2014), Beau et al (2014), Cecchetti and Kohler (2014), Gelain and Ilbas (2014), Ueda and Valencia (2014), and Kannan et al (2012). But none of these papers formally considers the strategic considerations between M&Ms, i.e.…”

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.…”