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Monetary and Macro-Prudential Policies: An Integrated Analysis

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Abstract

This paper studies monetary and macro-prudential policies in a simple model with both a nominal rigidity and a financial friction that give rise to price and financial stability objectives. We find that lowering the degree of nominal rigidity or increasing the strength of the interest rate response to inflation is always welfare increasing in the model, despite a tradeoff between price and financial stability that we document. Even though crises become more severe as the economy moves toward price flexibility, the cost of the nominal rigidity is always higher than the cost of the financial friction in welfare terms in the model. We also find that macro-prudential policy implemented by augmenting traditional monetary policy with a reaction to debt is always welfare increasing despite making crises more severe. In contrast, implementing macro-prudential policy with a separate tax on debt is always welfare decreasing despite making crises relatively less severe. The key difference lies in the behaviour of the nominal exchange rate, that is more depreciated in the economy with the tax on debt and increases the initial debt burden.

Suggested Citation

  • Christopher Otrok & Gianluca Benigno & Huigang Chen & Alessandro Rebucci & Eric R. Young, 2012. "Monetary and Macro-Prudential Policies: An Integrated Analysis," Working Papers 1208, Department of Economics, University of Missouri.
  • Handle: RePEc:umc:wpaper:1208
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    2. Gianluca Benigno & Huigang Chen & Christopher Otrok & Alessandro Rebucci & Eric R. Young, 2011. "Revisiting Overborrowing and its Policy Implications," Central Banking, Analysis, and Economic Policies Book Series,in: Luis Felipe Céspedes & Roberto Chang & Diego Saravia (ed.), Monetary Policy under Financial Turbulence, edition 1, volume 16, chapter 6, pages 145-184 Central Bank of Chile.
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    5. Lambertini, Luisa & Mendicino, Caterina & Teresa Punzi, Maria, 2013. "Leaning against boom–bust cycles in credit and housing prices," Journal of Economic Dynamics and Control, Elsevier, vol. 37(8), pages 1500-1522.
    6. 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.
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    13. Benigno, Gianluca & Chen, Huigang & Otrok, Christopher & Rebucci, Alessandro & Young, Eric R, 2012. "Optimal Policy for Macro-Financial Stability," CEPR Discussion Papers 9223, C.E.P.R. Discussion Papers.
    14. Braggion, Fabio & Christiano, Lawrence J. & Roldos, Jorge, 2009. "Optimal monetary policy in a [`]sudden stop'," Journal of Monetary Economics, Elsevier, vol. 56(4), pages 582-595, May.
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    18. Benigno, Gianluca & Chen, Huigang & Otrok, Christopher & Rebucci, Alessandro & Young, Eric R., 2013. "Financial crises and macro-prudential policies," Journal of International Economics, Elsevier, vol. 89(2), pages 453-470.
    19. Ms. Filiz D Unsal, 2011. "Capital Flows and Financial Stability: Monetary Policy and Macroprudential Responses," IMF Working Papers 2011/189, International Monetary Fund.
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    21. John B. Taylor, 2009. "The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong," NBER Working Papers 14631, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Young, Eric R., 2012. "Robust policymaking in the face of sudden stops," Journal of Monetary Economics, Elsevier, vol. 59(5), pages 512-527.
    2. Pierre-Richard Agénor & Luiz A. Pereira da Silva, 2013. "Inflation Targeting and Financial Stability: A Perspective from the Developing World," Working Papers Series 324, Central Bank of Brazil, Research Department.
    3. Gurnain Kaur Pasricha, 2017. "Policy Rules for Capital Controls," BIS Working Papers 670, Bank for International Settlements.
    4. Bianca De Paoli & Matthias Paustian, 2013. "Coordinating monetary and macroprudential policies," Staff Reports 653, Federal Reserve Bank of New York.
    5. Fabrice Collard & Harris Dellas & Behzad Diba & Olivier Loisel, 2017. "Optimal Monetary and Prudential Policies," American Economic Journal: Macroeconomics, American Economic Association, vol. 9(1), pages 40-87, January.
    6. Benigno, Gianluca & Chen, Huigang & Otrok, Christopher & Rebucci, Alessandro & Young, Eric R., 2013. "Financial crises and macro-prudential policies," Journal of International Economics, Elsevier, vol. 89(2), pages 453-470.
    7. Emmanuel Carré & Jézabel Couppey-Soubeyran & Salim Dehmej, 2015. "La coordination entre politique monétaire et politique macroprudentielle. Que disent les modèles dsge ?," Revue économique, Presses de Sciences-Po, vol. 66(3), pages 541-572.
    8. Akıncı, Özge & Chahrour, Ryan, 2018. "Good news is bad news: Leverage cycles and sudden stops," Journal of International Economics, Elsevier, vol. 114(C), pages 362-375.
    9. Cao, Jin & Chollete, Lorán, 2017. "Monetary policy and financial stability in the long run: A simple game-theoretic approach," Journal of Financial Stability, Elsevier, vol. 28(C), pages 125-142.
    10. Cesa-Bianchi, Ambrogio & Rebucci, Alessandro, 2017. "Does easing monetary policy increase financial instability?," Journal of Financial Stability, Elsevier, vol. 30(C), pages 111-125.
    11. Louphou COULIBALY, 2018. "Monetary Policy in Sudden Stop-Prone Economies," Cahiers de recherche 06-2018, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
    12. Jean-Paul L'Huillier & Facundo Piguillem & Jean Flemming, 2015. "The Optimal Tradeoff Between Consumption Smoothing and Macroprudential Regulation," 2015 Meeting Papers 492, Society for Economic Dynamics.
    13. Lambertini, Luisa & Mendicino, Caterina & Teresa Punzi, Maria, 2013. "Leaning against boom–bust cycles in credit and housing prices," Journal of Economic Dynamics and Control, Elsevier, vol. 37(8), pages 1500-1522.
    14. Paolo Angelini & Sergio Nicoletti-Altimari & Ignazio Visco, 2012. "Macroprudential, microprudential and monetary policies: conflicts, complementarities and trade-offs," Questioni di Economia e Finanza (Occasional Papers) 140, Bank of Italy, Economic Research and International Relations Area.
    15. Marco Ortiz & Gerardo Herrera, 2020. "Heterogeneous Credit Constraints and Optimal Monetary Policy," Working Papers 164, Peruvian Economic Association.

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    More about this item

    Keywords

    Financial Frictions; Financial Crises; Financial Stability; Macro-Prudential Policies; Nominal Rigidities; Monetary Policy.;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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