Macro-Prudential Policy and the Conduct of Monetary Policy

In this paper, we analyse the interactions between monetary and macro-prudential policies and the circumstances under which such interactions call for their coordinated implementation. We start with a review of the interdependencies between monetary and macro-prudential policies. Then, we use a dynamic stochastic general equilibrium (DSGE) model incorporating financial frictions, heterogeneous agents and housing, which is estimated for both the euro area and the United States (US) over the period 1985-2010, to identify the circumstances under which monetary and macro-prudential policies may have compounding, neutral or conflicting impacts on price stability. We compare infl ation dynamics across four “policy regimes” depending on: (a) the monetary policy objectives —that is, whether the policy instrument, the short-term interest rate factors in financial stability considerations by leaning against credit growth; and (b) the existence, or not, of an authority in charge of a financial stability objective through the implementation of macro-prudential policies that can “lean against credit” without affecting the short-term interest rate. Our main results are: (1) under most circumstances, macro-prudential policies have a limited effect on infl ation; (2) the policy regime impacts infl ation dynamics mainly in the case of financial shocks (shocks to asset prices and credit); (3) under those circumstances, the best outcome in terms of price stability is achieved by combining an independent monetary policy strictly focused on price stability and an independent macro-prudential policy leaning against credit growth; (4) the performance of this policy regime, where monetary policy and macro-prudential policies have separate assignments in terms of objectives, is improved upon if monetary policy takes into account any macro-economic effects resulting from macro-prudential policies. Finally, we assess the extent to which the new institutional arrangements adopted in Europe or (This abstract was borrowed from another version of this item.)