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Monetary and Macro-Prudential Policies: An Integrated Analysis

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Abstract

This paper studies monetary and macro-prudential policies in a simple model with both a nominal rigidity and a financial friction that give rise to price and financial stability objectives. We find that lowering the degree of nominal rigidity or increasing the strength of the interest rate response to inflation is always welfare increasing in the model, despite a tradeoff between price and financial stability that we document. Even though crises become more severe as the economy moves toward price flexibility, the cost of the nominal rigidity is always higher than the cost of the financial friction in welfare terms in the model. We also find that macro-prudential policy implemented by augmenting traditional monetary policy with a reaction to debt is always welfare increasing despite making crises more severe. In contrast, implementing macro-prudential policy with a separate tax on debt is always welfare decreasing despite making crises relatively less severe. The key difference lies in the behaviour of the nominal exchange rate, that is more depreciated in the economy with the tax on debt and increases the initial debt burden.

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File URL: http://economics.missouri.edu/working-papers/2012/WP1208_otrok.pdf
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Bibliographic Info

Paper provided by Department of Economics, University of Missouri in its series Working Papers with number 1208.

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Length: 39 pgs.
Date of creation: 24 Jul 2012
Date of revision:
Handle: RePEc:umc:wpaper:1208

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Keywords: Financial Frictions; Financial Crises; Financial Stability; Macro-Prudential Policies; Nominal Rigidities; Monetary Policy.;

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References

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  1. D. Filiz Unsal, 2011. "Capital Flows and Financial Stability," IMF Working Papers 11/189, International Monetary Fund.
  2. Ambrogio Cesa-Bianchi & Alessandro Rebucci, 2013. "Does Easing Monetary Policy Increase Financial Instability?," IDB Publications 79499, Inter-American Development Bank.
  3. Gianluca Benigno & Huigang Chen & Christopher Otrok & Alessandro Rebucci & Eric R. Young, 2010. "Revisiting Overborrowing and Its Policy Implications," IDB Publications 6855, Inter-American Development Bank.
  4. Huigang Chen & Eric Young & Christopher Otrok & Alessandro Rebucci & Gianluca Benigno, 2013. "Optimal Policy for Macro-Financial Stability," 2013 Meeting Papers, Society for Economic Dynamics 636, Society for Economic Dynamics.
  5. Javier Bianchi, 2011. "Overborrowing and Systemic Externalities in the Business Cycle," American Economic Review, American Economic Association, vol. 101(7), pages 3400-3426, December.
  6. Pau Rabanal & Dominic Quint, 2013. "Monetary and Macroprudential Policy in an Estimated DSGE Model of the Euro Area," 2013 Meeting Papers, Society for Economic Dynamics 604, Society for Economic Dynamics.
  7. Bruce Greenwald & Joseph E. Stiglitz, 1993. "New and Old Keynesians," Journal of Economic Perspectives, American Economic Association, vol. 7(1), pages 23-44, Winter.
  8. Fernández, Andrés & Gulan, Adam, 2012. "Interest rates and business cycles in emerging economies: The role of financial frictions," Research Discussion Papers 23/2012, Bank of Finland.
  9. Gianluca Benigno & Huigang Chen & Christopher Otrok & Alessandro Rebucci & Eric Young, 2011. "Financial Crises and Macro-Prudential Policies," Research Department Publications 4710, Inter-American Development Bank, Research Department.
  10. Jeanne, O. & Korinek, A., 2010. "Managing Credit Booms and Busts: A Pigouvian Taxation Approach," Discussion Paper, Tilburg University, Center for Economic Research 2010-108S, Tilburg University, Center for Economic Research.
  11. Javier Bianchi & Enrique G. Mendoza, 2010. "Overborrowing, Financial Crises and 'Macro-prudential' Taxes," NBER Working Papers 16091, National Bureau of Economic Research, Inc.
  12. D. Filiz Unsal, 2013. "Capital Flows and Financial Stability: Monetary Policy and Macroprudential Responses," International Journal of Central Banking, International Journal of Central Banking, International Journal of Central Banking, vol. 9(1), pages 233-285, March.
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Cited by:
  1. Benigno, Gianluca & Chen, Huigang & Otrok, Christopher & Rebucci, Alessandro & Young, Eric R, 2011. "Financial Crisis and Macro-Prudential Policies," CEPR Discussion Papers 8175, C.E.P.R. Discussion Papers.
  2. Luisa Lambertini & Caterina Mendicino & Maria Teresa Punzi, 2011. "Leaning Against Boom-Bust Cycles in Credit and Housing Prices," Working Papers CELEG 1104, Dipartimento di Economia e Finanza, LUISS Guido Carli.
  3. Pierre-Richard Agénor & Luiz A. Pereira da Silva, 2013. "Inflation Targeting and Financial Stability: A Perspective from the Developing World," Working Papers Series, Central Bank of Brazil, Research Department 324, Central Bank of Brazil, Research Department.
  4. Fabrice Collard & Harris Dellas & Behzad Diba & Olivier Loisel, 2012. "Optimal Monetary and Prudential Policies," Working Papers 2012-34, Centre de Recherche en Economie et Statistique.
  5. Paolo Angelini & Sergio Nicoletti-Altimari & Ignazio Visco, 2012. "Macroprudential, microprudential and monetary policies: conflicts, complementarities and trade-offs," Questioni di Economia e Finanza (Occasional Papers) 140, Bank of Italy, Economic Research and International Relations Area.
  6. Bianca De Paoli & Matthias Paustian, 2013. "Coordinating monetary and macroprudential policies," Staff Reports 653, Federal Reserve Bank of New York.

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