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The Role of Macroprudential Policy in Times of Trouble

Author

Listed:
  • Chadha, J. S.
  • Corrado, G.
  • Corrado, L.
  • Buratta, I. D. L.

Abstract

We investigate whether macroprudential policies support broader economic stability, particularly the welfare of households. For this purpose, we develop a New Keynesian business cycle model with agents subject to credit constraints and asset price fluctuations. The model differentiates between savers, who own firms and banks, and borrowers. The commercial bank sets the loan rate as a function of risk, specifically the value of housing collateral. We use occasionally binding constraints to capture nonlinearities arising from the zero lower bound (ZLB) on the policy interest rate and the borrowing constraint faced by borrower households. We examine two macroprudential tools: a countercyclical loan-to-value (LTV) ratio and a bank reserve requirement. We find that macroprudential tools significantly reduce the volatility of consumption and lending cycles and decrease both the expected frequency and severity of ZLB episodes. More generally, by attenuating the variance of the business cycle, particularly for borrower households, macroprudential tools reduce the need for monetary policy interventions.

Suggested Citation

  • Chadha, J. S. & Corrado, G. & Corrado, L. & Buratta, I. D. L., 2025. "The Role of Macroprudential Policy in Times of Trouble," Cambridge Working Papers in Economics 2561, Faculty of Economics, University of Cambridge.
    • Handle: RePEc:cam:camdae:2561
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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