Policy Mandates for Macro-Prudential and Monetary Policies in a New Keynesian Framework

44 Pages Posted: 20 Jun 2015

See all articles by Paul Levine

Paul Levine

School of Economics, University of Surrey

Diana Lima

University of Surrey

Date Written: June 19, 2015

Abstract

In the aftermath of the financial crisis, the role of monetary policy and macro-prudential regulation in promoting financial stability is under discussion. The old debate concerning whether monetary policy should respond to credit and asset price bubbles was revived, whereas macro-prudential regulation is being assessed as an alternative macroeconomic tool to deal with financial imbalances. The paper explores both sides of the debate in a New Keynesian framework with financial frictions by comparing the welfare and stabilisation impacts of distinct policy regimes. First, we investigate whether there is a welfare benefit from monetary policy leaning against financial instability. We show that monetary policy rules of this type perform better than conventional monetary rules. Second, by introducing macro-prudential regulation in the model, results from optimal policy analysis suggest also that there are welfare gains, even in the case in which monetary and macro-prudential authorities are independent and react to their own policy goal.

Keywords: DSGE; financial frictions; macro-prudential policy; monetary policy

JEL Classification: E30, E50, G28

Suggested Citation

Levine, Paul L. and Lima, Diana, Policy Mandates for Macro-Prudential and Monetary Policies in a New Keynesian Framework (June 19, 2015). ECB Working Paper No. 1784. Available at SSRN: https://ssrn.com/abstract=2620725

Paul L. Levine

School of Economics, University of Surrey ( email )

Guildford
Surrey GU2 7XH
United Kingdom
+44 1483 259 380 Ext. 2773 (Phone)
+44 1483 259 548 (Fax)

Diana Lima (Contact Author)

University of Surrey ( email )

Guildford
Guildford, Surrey GU2 5XH
United Kingdom

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