Macro-Prudential Policy and the Conduct of Monetary Policy

Abstract

In this paper, we analyze the interactions between monetary and macro-prudential policies and the circumstances under which such interactions call for their coordinated implementation. We start with a review of the interdependencies between monetary and macro-prudential policies. Then, we use a DSGE model incorporating financial frictions, heterogeneous agents and housing, which is estimated for the euro area over the period 1985-2010, to identify the circumstances under which monetary and macro-prudential policies may have compounding, neutral or conflicting impacts on price stability. We compare inflation dynamics across four 'policy regimes' depending on: the monetary policy objectives – that is, whether the policy instrument, the short-term interest rate factors in financial stability considerations by leaning against credit growth; and the existence, or not, of an authority in charge of a financial stability objective through the implementation of macro-prudential policies that can 'lean against credit' without affecting the short-term interest rate.

Our main result is that under most circumstances, macro-prudential policies have either a limited or a stabilizing effect on inflation.

Keywords: monetary policy, financial stability, macro-prudential policy, ESRB

JEL Classification: E51, E58, E37, G13, G18