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The interaction between monetary and macroprudential policy: Should central banks "lean against the wind" to foster macrofinancial stability?

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  • Krug, Sebastian

Abstract

The extensive harm caused by the financial crisis raises the question of whether policymakers could have done more to prevent the build-up of financial imbalances. This paper aims to contribute to the field of regulatory impact assessment by taking up the revived debate on whether central banks should "lean against the wind" or not. Currently, there is no consensus on whether monetary policy is, in general, able to support the resilience of the financial system or if this task should better be left to the macroprudential approach of financial regulation. We aim to shed light on this issue by analyzing distinct policy regimes within an agent-based computational macro-model with endogenous money. We find that policies make use of their comparative advantage leading to superior outcomes concerning their respective intended objectives. In particular, we show that "leaning against the wind" should only serve as first line of defense in the absence of a prudential regulatory regime and that price stability does not necessarily mean financial stability. Moreover, macroprudential regulation as unburdened policy instrument is able to dampen the build-up of financial imbalances by restricting credit to the unsustainable high-leveraged part of the real economy. In contrast, leaning against the wind seems to have no positive impact on financial stability which strengthens proponents of Tinbergen's principle arguing that both policies are designed for their specific purpose and that they should be used accordingly.

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  • Krug, Sebastian, 2015. "The interaction between monetary and macroprudential policy: Should central banks "lean against the wind" to foster macrofinancial stability?," Economics Working Papers 2015-08, Christian-Albrechts-University of Kiel, Department of Economics.
  • Handle: RePEc:zbw:cauewp:201508
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    2. Popoyan, Lilit & Napoletano, Mauro & Roventini, Andrea, 2017. "Taming macroeconomic instability: Monetary and macro-prudential policy interactions in an agent-based model," Journal of Economic Behavior & Organization, Elsevier, vol. 134(C), pages 117-140.
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    8. Michel Alexandre & Gilberto Tadeu Lima, 2020. "Combining monetary policy and prudential regulation: an agent-based modeling approach," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 15(2), pages 385-411, April.
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    More about this item

    Keywords

    Financial Stability; Monetary Economics; Macroprudential Policy; Financial Regulation; Central Banking; Agent-Based Macroeconomics;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • G01 - Financial Economics - - General - - - Financial Crises
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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