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The Macroprudential Toolkit: Effectiveness and Interactions

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  • Stephen Millard
  • Margarita Rubio
  • Alexandra Varadi

Abstract

We use a DSGE model with financial frictions and with macroprudential limits on both banks and mortgage borrowers, in the form of capital requirements and maximum debt‐service ratios. We then examine: (i) the impact of different combinations of macroprudential limits on key macroeconomic aggregates; (ii) their interaction with each other and with monetary policy; and (iii) their effects on the volatility of key macroeconomic variables and on welfare. We find that capital requirements on banks are the optimal tool when faced with a financial shock, as they nullify the effects of financial frictions and reduce the effects of the shock on the real economy. Instead, limits on mortgage debt‐service ratios are optimal following a housing demand shock, as they disconnect the housing market from the real economy, reducing the volatility of inflation. Hence, no policy on its own is sufficient to deal with a wide range of shocks.

Suggested Citation

  • Stephen Millard & Margarita Rubio & Alexandra Varadi, 2024. "The Macroprudential Toolkit: Effectiveness and Interactions," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 86(2), pages 335-384, April.
    • Handle: RePEc:bla:obuest:v:86:y:2024:i:2:p:335-384
    DOI: 10.1111/obes.12582
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