Optimal Monetary and Macroprudential Policies: Gains and Pitfalls in a Model of Financial Intermediation

FEDS Working Paper No. 2015-078

http://dx.doi.org/10.17016/FEDS.2015.078

56 Pages Posted: 27 Sep 2015

See all articles by Michael T. Kiley

Michael T. Kiley

Board of Governors of the Federal Reserve System

Jae Sim

Board of Governors of the Federal Reserve System

Date Written: September 4, 2015

Abstract

We estimate a quantitative general equilibrium model with nominal rigidities and financial intermediation to examine the interaction of monetary and macroprudential stabilization policies. The estimation procedure uses credit spreads to help identify the role of financial shocks amenable to stabilization via monetary or macroprudential instruments. The estimated model implies that monetary policy should not respond strongly to the credit cycle and can only partially insulate the economy from the distortionary effects of financial frictions/shocks. A counter-cyclical macroprudential instrument can enhance welfare, but faces important implementation challenges. In particular, a Ramsey planner who adjusts a leverage tax in an optimal way can largely insulate the economy from shocks to intermediation, but a simple-rule approach must be cautious not to limit credit expansions associated with efficient investment opportunities. These results demonstrate the importance of considering both optimal Ramsey policies and simpler, but more practical, approaches in an empirically grounded model.

Keywords: Bayesian estimation, DSGE models, Macroprudential policy, Monetary policy

JEL Classification: E58, E61, G18

Suggested Citation

Kiley, Michael T. and Sim, Jae W., Optimal Monetary and Macroprudential Policies: Gains and Pitfalls in a Model of Financial Intermediation (September 4, 2015). http://dx.doi.org/10.17016/FEDS.2015.078. Available at SSRN: https://ssrn.com/abstract=2665691 or http://dx.doi.org/10.2139/ssrn.2665691

Michael T. Kiley (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th and C Streets, NW
Washington, DC 20551
United States
202-452-2448 (Phone)
202-452-5296 (Fax)

Jae W. Sim

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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