Monetary Policy, Macroprudential Policy, and Financial Stability
44 Pages Posted: 19 Feb 2019
Date Written: February 2019
This paper reexamines from a theoretical perspective the role of monetary and macroprudential policies in addressing the build-up of risks in the financial system. We construct a stylized general equilibrium model in which the key friction comes from a moral hazard problem in firms' financing that banks' equity capital serves to ameliorate. Tight monetary policy is introduced by open market sales of government debt, and tight macroprudential policy by an increase in capital requirements. We show that both policies are useful, but macroprudential policy is more effective in terms of financial stability and leads to higher social welfare.
Keywords: Bank monitoring, Capital requirements, Financial Stability, intermediation margin, macroprudential policy, monetary policy
JEL Classification: E44, E52, G21, G28
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