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Countercyclical Macro Prudential Policies in a Supporting Role to Monetary Policy

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  • Papa M'B. P. N'Diaye
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    Abstract

    This paper explores how prudential regulations can support monetary policy in reducing output fluctuations while maintaining financial stability. It uses a new framework that blends a standard model for monetary policy analysis with a contingent claims model of financial sector vulnerabilities. The results suggest that binding countercyclical prudential regulations can help reduce output fluctuations and lessen the risk of financial instability. More specifically, countercyclical rules such as countercyclical capital adequacy rules, can allow monetary authorities to achieve the same output and inflation objectives but with smaller adjustments in interest rates. The countercyclical rules can help stem swings in asset prices, lean against a financial accelerator process, and thereby help to lower risks of macroeconomic and financial instability. In economies with fixed exchange rates, where countercyclical monetary policy is not possible, prudential regulations can provide a useful mechanism for mitigating a run-up in asset prices and for promoting output stability.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 09/257.

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    Length: 22
    Date of creation: 01 Nov 2009
    Date of revision:
    Handle: RePEc:imf:imfwpa:09/257

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    Related research

    Keywords: Capital; Economic models; Financial stability; Market interest rates; inflation; monetary policy; aggregate demand; monetary fund; nominal interest rate; monetary policy rule; monetary authorities; relative price; price inflation; inflation equation; monetary reaction function; monetary policy rules; independent monetary policy; central bank; price level; monetary authority; price stability; inflationary pressures; inflation rate; monetary conditions; foreign currency; long-term interest rates; increase in interest rates; monetary policy instrument; rational expectations; monetary analysis; real interest rate; inflation targeting;

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    1. Claudio Borio & Mathias Drehmann, 2009. "Assessing the risk of banking crises - revisited," BIS Quarterly Review, Bank for International Settlements, Bank for International Settlements, March.
    2. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, Elsevier, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier.
    3. Olivier Blanchard & Jordi Gali, 2006. "A new Keynesian model with unemployment," Working Paper Research, National Bank of Belgium 92, National Bank of Belgium.
    4. Alan Greenspan, 2004. "Risk and Uncertainty in Monetary Policy," American Economic Review, American Economic Association, American Economic Association, vol. 94(2), pages 33-40, May.
    5. Jack Selody & Carolyn Wilkins, 2004. "Asset Prices and Monetary Policy: A Canadian Perspective on the Issues," Bank of Canada Review, Bank of Canada, Bank of Canada, vol. 2004(Autumn), pages 3-14.
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    Cited by:
    1. Paolo Angelini & Stefano Neri & Fabio Panetta, 2011. "Monetary and macroprudential policies," Temi di discussione (Economic working papers), Bank of Italy, Economic Research and International Relations Area 801, Bank of Italy, Economic Research and International Relations Area.
    2. Leonardo Luna & Dale F. Gray & Jorge Restrepo & Carlos Garcia, 2011. "Incorporating Financial Sector Risk Into Monetary Policy Models," IMF Working Papers 11/228, International Monetary Fund.

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