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Countercyclical Macro Prudential Policies in a Supporting Role to Monetary Policy

  • Papa M'B. P. N'Diaye
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    This paper explores how prudential regulations can support monetary policy in reducing output fluctuations while maintaining financial stability. It uses a new framework that blends a standard model for monetary policy analysis with a contingent claims model of financial sector vulnerabilities. The results suggest that binding countercyclical prudential regulations can help reduce output fluctuations and lessen the risk of financial instability. More specifically, countercyclical rules such as countercyclical capital adequacy rules, can allow monetary authorities to achieve the same output and inflation objectives but with smaller adjustments in interest rates. The countercyclical rules can help stem swings in asset prices, lean against a financial accelerator process, and thereby help to lower risks of macroeconomic and financial instability. In economies with fixed exchange rates, where countercyclical monetary policy is not possible, prudential regulations can provide a useful mechanism for mitigating a run-up in asset prices and for promoting output stability.

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    Paper provided by International Monetary Fund in its series IMF Working Papers with number 09/257.

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    Length: 22
    Date of creation: 01 Nov 2009
    Date of revision:
    Handle: RePEc:imf:imfwpa:09/257
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    1. Ben Bernanke & Mark Gertler & Simon Gilchrist, 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," NBER Working Papers 6455, National Bureau of Economic Research, Inc.
    2. Olivier Blanchard & Jordi Gali, 2007. "A New Keynesian Model with Unemployment," Kiel Working Papers 1335, Kiel Institute for the World Economy.
    3. Claudio Borio & Mathias Drehmann, 2009. "Assessing the risk of banking crises - revisited," BIS Quarterly Review, Bank for International Settlements, March.
    4. Alan Greenspan, 2004. "Risk and Uncertainty in Monetary Policy," American Economic Review, American Economic Association, vol. 94(2), pages 33-40, May.
    5. Jack Selody & Carolyn Wilkins, 2004. "Asset Prices and Monetary Policy: A Canadian Perspective on the Issues," Bank of Canada Review, Bank of Canada, vol. 2004(Autumn), pages 3-14.
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