Financial Stability, Growth and Macroprudential Policy

60 Pages Posted: 3 Mar 2018 Last revised: 18 Aug 2020

See all articles by Chang Ma

Chang Ma

Fudan University - Fanhai International School of Finance (FISF)

Date Written: September 18, 2018

Abstract

This paper studies the effect of optimal macroprudential policy in a small open economy model where growth is endogenous. By introducing endogenous growth, this model is able to capture the persistent effect of financial crises on output, which is different from previous literature but consistent with the data. Furthermore, there is a new policy trade-off between the cyclical and trend consumption growth. By constraining external borrowing to reduce systemic risk, the macroprudential policy hurts trend growth in good times but reduces the permanent output loss from a crisis. In a calibrated version of my model, I find that the optimal macroprudential policy significantly enhances financial stability (reducing the probability of crisis by two-thirds) at the cost of lowering average growth by a small amount. The welfare gains from policy intervention do not increase with endogenous growth because crises are rare events.

Keywords: Macroprudential Policy, Financial Crises, Endogenous Growth

JEL Classification: E44, F38, F43, G38, O30

Suggested Citation

Ma, Chang, Financial Stability, Growth and Macroprudential Policy (September 18, 2018). Available at SSRN: https://ssrn.com/abstract=3120661 or http://dx.doi.org/10.2139/ssrn.3120661

Chang Ma (Contact Author)

Fudan University - Fanhai International School of Finance (FISF) ( email )

China

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