When Capital Adequacy and Interest Rate Policy are Substitutes (and When They are Not)

22 Pages Posted: 8 May 2012

See all articles by Stephen G. Cecchetti

Stephen G. Cecchetti

Brandeis International Business School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Marion Kohler

Bank for International Settlements (BIS)

Date Written: May 1, 2012

Abstract

Prudential instruments are commonly seen as the tools that can be used to deliver the macroprudential policy goals of reducing the frequency and severity of financial crises. And interest rates are traditionally viewed as the means to deliver the macroeconomic stabilization goals of low, stable inflation and sustainable, stable growth. But, at the macroeconomic level, these two sets of policy tools have quite a bit in common. We use a simple macroeconomic model to study the extent to which capital adequacy requirements and interest rates might be substitutes in meeting the objective of stabilizing the economy. We find that in our model both are substitutes for achieving conventional monetary policy objectives. In addition, we show that, in principle, they can both be used to meet financial stability objectives. This implies a need to coordinate the use of macroprudential and traditional monetary policy tools, a need that has clear implications for the construction of the policy framework designed to deliver the joint objectives of macroeconomic and financial stability.

Keywords: monetary policy, capital adequacy policy, financial stability policy

JEL Classification: E5, G2

Suggested Citation

Cecchetti, Stephen G. and Kohler, Marion, When Capital Adequacy and Interest Rate Policy are Substitutes (and When They are Not) (May 1, 2012). BIS Working Paper No. 379. Available at SSRN: https://ssrn.com/abstract=2054508

Stephen G. Cecchetti (Contact Author)

Brandeis International Business School ( email )

415 South Street
Waltham, MA 02453
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States
212-720-8629 (Phone)
212-720-2630 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Marion Kohler

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

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