Macroprudential Policy: Its Effects and Relationship to Monetary Policy

Hyunduk Suh
2012 Social Science Research Network  
This paper examines the interactions of macroprudential policy and monetary policy in a New Keynesian DSGE model with financial frictions. Macroprudential policy can stabilize credit cycles. However, a macroprudential instrument that aims to stabilize a specific segment of the credit market can cause regulatory arbitrage, that is, a reallocation of credit to a less regulated part of the market. Within this model, welfare-maximizing monetary policy aims to stabilize only inflation and
more » ... tion and macroprudential policy only stabilizes credit. Two aspects of the model account for this dichotomy. First, credit stabilization is welfare improving because lower volatility is compensated by higher mean equilibrium credit and capital. Second, monetary policy is sub-optimal for credit stabilization. The reason is that it operates on the decisions of borrowers and savers, while macroprudential policy operates only on the decisions of borrowers. JEL Classification: E44, E50, E61
doi:10.2139/ssrn.2182741 fatcat:3fy6agx46na43ckrmddptdu42m