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Macroprudential and Monetary Policies: Implications for Financial Stability and Welfare

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  • José A Carrasco-Gallego
  • Margarita Rubio

Abstract

In this paper, we analyse the implications of macroprudential and monetary policies for business cycles, welfare, and .nancial stability. We consider a dynamic stochastic general equilibrium (DSGE) model with housing and collateral constraints. A macroprudential rule on the loan-to-value ratio (LTV), which responds to output and house price deviations, interacts with a traditional Taylor rule for monetary policy. From a positive perspective, introducing a macroprudential tool mitigates the effects of booms in the economy by restricting credit. However, monetary and macroprudential policies may enter in conflict when shocks come from the supply-side of the economy. From a normative point of view, results show that the introduction of this macroprudential measure is welfare improving. Then, we calculate the combination of policy parameters that maximizes welfare and find that the optimal LTV rule should respond relatively more aggressively to house prices than to output deviations. Finally, we study the efficiency of the policy mix. We propose a tool that includes not only the variability of output and inflation but also the variability of borrowing, to capture the effects of policies on financial stability: a three-dimensional policy frontier (3DPF). We find that both policies acting together unambiguously improve the stability of the system.

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Bibliographic Info

Paper provided by University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM) in its series Discussion Papers with number 2013/04.

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Date of creation: 2013
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Handle: RePEc:not:notcfc:13/04

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Keywords: Macroprudential; monetary policy; welfare; financial stability; three-dimensional policy frontier; loan-to-value; Taylor curve;

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References

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  1. Jeffrey R. Campbell & Zvi Hercowitz, 2006. "Welfare implications of the transition to high household debt," Working Paper Series, Federal Reserve Bank of Chicago WP-06-27, Federal Reserve Bank of Chicago.
  2. Matteo Iacoviello & Stefano Neri, 2008. "Housing market spillovers : evidence from an estimated DSGE model," Working Paper Research, National Bank of Belgium 145, National Bank of Belgium.
  3. Funke, Michael & Paetz, Michael, 2012. "A DSGE-Based Assessment of Nonlinear Loan-to-Value Policies: Evidence from Hong Kong," BOFIT Discussion Papers, Bank of Finland, Institute for Economies in Transition 11/2012, Bank of Finland, Institute for Economies in Transition.
  4. Beau, D. & Clerc, L. & Mojon, B., 2011. "Macro-prudential policy and the conduct of monetary policy," Occasional papers, Banque de France 8, Banque de France.
  5. Andrea Pescatori & Caterino Mendicino, 2005. "Credit Frictions, Housing Prices and Optimal Monetary Policy Rules," Money Macro and Finance (MMF) Research Group Conference 2005, Money Macro and Finance Research Group 67, Money Macro and Finance Research Group.
  6. Domeij, David & Floden, Martin, 2001. "The labor-supply elasticity and borrowing constraints: Why estimates are biased," Working Paper Series in Economics and Finance, Stockholm School of Economics 480, Stockholm School of Economics.
  7. Bennett T. McCallum, 2001. "Should Monetary Policy Respond Strongly to Output Gaps?," NBER Working Papers 8226, National Bureau of Economic Research, Inc.
  8. Ascari, Guido & Ropele, Tiziano, 2012. "Disinflation in a DSGE perspective: Sacrifice ratio or welfare gain ratio?," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 36(2), pages 169-182.
  9. Kannan Prakash & Rabanal Pau & Scott Alasdair M., 2012. "Monetary and Macroprudential Policy Rules in a Model with House Price Booms," The B.E. Journal of Macroeconomics, De Gruyter, De Gruyter, vol. 12(1), pages 1-44, June.
  10. Schmitt-Grohé, Stephanie & Uribe, Martín, 2001. "Solving Dynamic General Equilibrium Models Using a Second-Order Approximation to the Policy Function," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2963, C.E.P.R. Discussion Papers.
  11. Matteo Iacoviello, 2002. "House prices, borrowing constraints and monetary policy in the business cycle," Boston College Working Papers in Economics, Boston College Department of Economics 542, Boston College Department of Economics, revised 06 Dec 2004.
  12. Lawrance, Emily C, 1991. "Poverty and the Rate of Time Preference: Evidence from Panel Data," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 99(1), pages 54-77, February.
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As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Macroprudential and Monetary Policies: Implications for Financial Stability and Welfare
    by Christian Zimmermann in NEP-DGE blog on 2013-10-30 02:09:42

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