Coordination and non-coordination risks of monetary and macroprudential authorities: A robust welfare analysis

This study compares a central bank’s leaning against the wind approach with a mix of monetary and macroprudential policies under parameter uncertainty in an estimated DSGE model with two financial frictions. We show that uncertainty of the economic environment is an essential constituent in properly designing macroprudential policy. Although coordination between monetary and macroprudential policies minimizes the policymakers’ Bayesian risk, coordination and non-coordination risks threaten the goals of both authorities. The former describes the situation where the authorities partly resign from implementing the monetary policy objectives to stabilize macroprudential risk. The latter is when conducting a non-coordinated macroprudential policy induces higher total Bayesian risk than when only the central bank minimizes the expected total welfare loss. The robust Bayesian macroeconomic rules show that when financial shocks shrink the banks’ or entrepreneurial net worth, a contractionary macroprudential policy should be combined with an expansionary monetary policy. However, if capital adequacy ratio or risk shocks strike the economy, such a conflict in macroeconomics policy instruments disappears, thus synchronizing both policies.