IDEAS home Printed from https://ideas.repec.org/p/red/sed016/1461.html
   My bibliography  Save this paper

When the Central Bank Meets the Financial Authority: Strategic Interactions and Institutional Design

Author

Listed:
  • Victoria Nuguer

    (Banco de México)

  • Jessica Roldan-Pena

    (Banco de Mexico)

  • Enrique Mendoza

    (University of Pennsylvania)

  • Julio Carrillo

    (Banco de Mexico)

Abstract

We investigate the strategic interactions between the central bank and a financial authority in an economy distorted with nominal rigidities and credit frictions, and hit by financial shocks. Using a policy-rule approach, we find that introducing an independent financial instrument increases consumers’ welfare, versus the alternative of a central bank alone leaning against the financial shocks. Also, we find that when the two policymakers maximize welfare (our ideal case), the Nash equilibrium corresponds to the first best. However, under our implementable case, the policymakers face a conflict in objectives, as the central bank focuses on the stability of prices, while the financial authority on the stability of the credit spread. In such a case, cooperation across institutions is second best, while Nash is third best. However, if the policymakers have the same objectives, cooperation and Nash coincide and are second best.

Suggested Citation

  • Victoria Nuguer & Jessica Roldan-Pena & Enrique Mendoza & Julio Carrillo, 2016. "When the Central Bank Meets the Financial Authority: Strategic Interactions and Institutional Design," 2016 Meeting Papers 1461, Society for Economic Dynamics.
    • Handle: RePEc:red:sed016:1461
    as

    Download full text from publisher

    File URL: https://red-files-public.s3.amazonaws.com/meetpapers/2016/paper_1461.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Schmitt-Grohe, Stephanie & Uribe, Martin, 2007. "Optimal simple and implementable monetary and fiscal rules," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1702-1725, September.
    2. Dominic Quint & Pau Rabanal, 2014. "Monetary and Macroprudential Policy in an Estimated DSGE Model of the Euro Area," International Journal of Central Banking, International Journal of Central Banking, vol. 10(2), pages 169-236, June.
    3. Andrew P. Blake & Tatiana Kirsanova, 2011. "Inflation Conservatism and Monetary-Fiscal Policy Interactions," International Journal of Central Banking, International Journal of Central Banking, vol. 7(2), pages 41-83, June.
    4. Enrique G. Mendoza, 2018. "Macroprudential Policy: Promise and Challenges," Central Banking, Analysis, and Economic Policies Book Series, in: Enrique G. Mendoza & Ernesto Pastén & Diego Saravia (ed.),Monetary Policy and Global Spillovers: Mechanisms, Effects and Policy Measures, edition 1, volume 25, chapter 7, pages 225-277, Central Bank of Chile.
    5. Enrique G. Mendoza & Linda L. Tesar & Jing Zhang, 2014. "Saving Europe?: The Unpleasant Arithmetic of Fiscal Austerity in Integrated Economies," NBER Working Papers 20200, National Bureau of Economic Research, Inc.
    6. Janet L. Yellen, 2014. "Monetary Policy and Financial Stability : a speech at the 2014 Michel Camdessus Central Banking Lecture, International Monetary Fund, Washington, D.C., July 2, 2014," Speech 812, Board of Governors of the Federal Reserve System (U.S.).
    7. Frank Smets, 2014. "Financial Stability and Monetary Policy: How Closely Interlinked?," International Journal of Central Banking, International Journal of Central Banking, vol. 10(2), pages 263-300, June.
    8. Javier Bianchi & Enrique G. Mendoza, 2018. "Optimal Time-Consistent Macroprudential Policy," Journal of Political Economy, University of Chicago Press, vol. 126(2), pages 588-634.
    9. Lambertini, Luisa & Nuguer, Victoria & Uysal, Pinar, 2017. "Mortgage default in an estimated model of the U.S. housing market," Journal of Economic Dynamics and Control, Elsevier, vol. 76(C), pages 171-201.
    10. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393, Elsevier.
    11. John C. Williams, 2010. "Monetary policy in a low inflation economy with learning," Economic Review, Federal Reserve Bank of San Francisco, pages 1-12.
    12. Dixit, Avinash & Lambertini, Luisa, 2001. "Monetary-fiscal policy interactions and commitment versus discretion in a monetary union," European Economic Review, Elsevier, vol. 45(4-6), pages 977-987, May.
    13. Woodford, Michael, 2010. "Optimal Monetary Stabilization Policy," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 14, pages 723-828, Elsevier.
    14. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
    15. Chris Woolston, 2014. "Rice," Nature, Nature, vol. 514(7524), pages 49-49, October.
    16. Lars E.O. Svensson, 2016. "Inflation Targeting and "Leaning Against the Wind"," Israel Economic Review, Bank of Israel, vol. 13(1), pages 91-99.
    17. Taylor, John B. & Williams, John C., 2010. "Simple and Robust Rules for Monetary Policy," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 15, pages 829-859, Elsevier.
    18. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
    19. Vasco Cúrdia & Michael Woodford, 2010. "Credit Spreads and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 3-35, September.
    20. Gabriele Galati & Richhild Moessner, 2013. "Macroprudential Policy – A Literature Review," Journal of Economic Surveys, Wiley Blackwell, vol. 27(5), pages 846-878, December.
    21. Lawrence J. Christiano & Roberto Motto & Massimo Rostagno, 2014. "Risk Shocks," American Economic Review, American Economic Association, vol. 104(1), pages 27-65, January.
    22. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Solving dynamic general equilibrium models using a second-order approximation to the policy function," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 755-775, January.
    23. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    24. Benjamin M. Friedman & Michael Woodford (ed.), 2010. "Handbook of Monetary Economics," Handbook of Monetary Economics, Elsevier, edition 1, volume 3, number 3.
    25. Mendoza, Enrique G. & Tesar, Linda L., 2005. "Why hasn't tax competition triggered a race to the bottom? Some quantitative lessons from the EU," Journal of Monetary Economics, Elsevier, vol. 52(1), pages 163-204, January.
    26. Bodenstein, Martin & Guerrieri, Luca & LaBriola, Joe, 2019. "Macroeconomic policy games," Journal of Monetary Economics, Elsevier, vol. 101(C), pages 64-81.
    27. Paolo Angelini & Stefano Neri & Fabio Panetta, 2014. "The Interaction between Capital Requirements and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 46(6), pages 1073-1112, September.
    28. Angeloni, Ignazio & Faia, Ester, 2013. "Capital regulation and monetary policy with fragile banks," Journal of Monetary Economics, Elsevier, vol. 60(3), pages 311-324.
    29. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
    30. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
    31. Van der Ghote, Alejandro, 2018. "Coordinating monetary and financial regulatory policies," Working Paper Series 2155, European Central Bank.
    32. Michael Woodford, 2012. "Inflation Targeting and Financial Stability," NBER Working Papers 17967, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Julio A. Carrillo & Enrique G. Mendoza & Victoria Nuguer & Jessica Roldán-Peña, 2021. "Tight Money-Tight Credit: Coordination Failure in the Conduct of Monetary and Financial Policies," American Economic Journal: Macroeconomics, American Economic Association, vol. 13(3), pages 37-73, July.
    2. Verona, Fabio & Martins, Manuel M.F. & Drumond, Inês, 2017. "Financial shocks, financial stability, and optimal Taylor rules," Journal of Macroeconomics, Elsevier, vol. 54(PB), pages 187-207.
    3. Górajski, Mariusz & Kuchta, Zbigniew, 2023. "Coordination and non-coordination risks of monetary and macroprudential authorities: A robust welfare analysis," The North American Journal of Economics and Finance, Elsevier, vol. 67(C).
    4. Benes, Jaromir & Kumhof, Michael, 2015. "Risky bank lending and countercyclical capital buffers," Journal of Economic Dynamics and Control, Elsevier, vol. 58(C), pages 58-80.
    5. Manuel A. Muñoz, 2021. "Rethinking Capital Regulation: The Case for a Dividend Prudential Target," International Journal of Central Banking, International Journal of Central Banking, vol. 17(3), pages 271-336, September.
    6. Matthieu Darracq Paries, 2018. "Financial frictions and monetary policy conduct," Erudite Ph.D Dissertations, Erudite, number ph18-01 edited by Ferhat Mihoubi, December.
    7. Tayler, William J. & Zilberman, Roy, 2016. "Macroprudential regulation, credit spreads and the role of monetary policy," Journal of Financial Stability, Elsevier, vol. 26(C), pages 144-158.
    8. Laséen, Stefan & Pescatori, Andrea & Turunen, Jarkko, 2017. "Systemic risk: A new trade-off for monetary policy?," Journal of Financial Stability, Elsevier, vol. 32(C), pages 70-85.
    9. Lieberknecht, Philipp, 2018. "Financial Frictions, the Phillips Curve and Monetary Policy," MPRA Paper 89429, University Library of Munich, Germany.
    10. Lewis, Vivien & Roth, Markus, 2018. "Interest rate rules under financial dominance," Journal of Economic Dynamics and Control, Elsevier, vol. 95(C), pages 70-88.
    11. Tayler, William & Zilberman, Roy, 2014. "Macroprudential Regulation and the Role of Monetary Policy," Dynare Working Papers 37, CEPREMAP.
    12. Agur, Itai & Demertzis, Maria, 2019. "Will macroprudential policy counteract monetary policy’s effects on financial stability?," The North American Journal of Economics and Finance, Elsevier, vol. 48(C), pages 65-75.
    13. Nathan S. Balke & Enrique Martinez-Garcia & Zheng Zeng, 2017. "Understanding the Aggregate Effects of Credit Frictions and Uncertainty," Globalization Institute Working Papers 317, Federal Reserve Bank of Dallas.
    14. Ioanna Kokores, 2015. "Lean-Against-the-Wind Monetary Policy: The Post-Crisis Shift in the Literature," SPOUDAI Journal of Economics and Business, SPOUDAI Journal of Economics and Business, University of Piraeus, vol. 65(3-4), pages 66-99, july-Dece.
    15. repec:zbw:bofrdp:2016_016 is not listed on IDEAS
    16. Mădălina-Gabriela ANGHEL & Constantin ANGHELACHE & Ana CARP, 2017. "The main correlations between the monetary-banking indicators," Theoretical and Applied Economics, Asociatia Generala a Economistilor din Romania - AGER, vol. 0(2(611), S), pages 99-110, Summer.
    17. Dominic Quint & Pau Rabanal, 2014. "Monetary and Macroprudential Policy in an Estimated DSGE Model of the Euro Area," International Journal of Central Banking, International Journal of Central Banking, vol. 10(2), pages 169-236, June.
    18. Silvestrini, Andrea & Zaghini, Andrea, 2015. "Financial shocks and the real economy in a nonlinear world: From theory to estimation," Journal of Policy Modeling, Elsevier, vol. 37(6), pages 915-929.
    19. Mendicino, Caterina & Nikolov, Kalin & Suarez, Javier & Supera, Dominik, 2020. "Bank capital in the short and in the long run," Journal of Monetary Economics, Elsevier, vol. 115(C), pages 64-79.
    20. Luca Onorante & Matija Lozej & Ansgar Rannenberg, 2017. "Countercyclical capital regulation in a small open economy DSGE model," IFC Bulletins chapters, in: Bank for International Settlements (ed.), Data needs and Statistics compilation for macroprudential analysis, volume 46, Bank for International Settlements.
    21. Caterina Mendicino & Kalin Nikolov & Javier Suarez & Dominik Supera, 2018. "Optimal Dynamic Capital Requirements," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 50(6), pages 1271-1297, September.

    More about this item

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:red:sed016:1461. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Christian Zimmermann (email available below). General contact details of provider: https://edirc.repec.org/data/sedddea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.