The Macroprudential Toolkit: Effectiveness and Interactions

49 Pages Posted: 19 Jan 2021

See all articles by Stephen Millard

Stephen Millard

Bank of England

Margarita Rubio

University of Nottingham

Alexandra Varadi

Bank of England

Date Written: January 15, 2021

Abstract

We use a DSGE model with financial frictions, leverage limits on banks, loan to value (LTV) limits and debt‑service ratio (DSR) limits on mortgage borrowing to examine: i) the effects of different macroprudential policies on key macro aggregates; ii) their interaction with each other and with monetary policy; and iii) their effects on the volatility of key macroeconomic variables and on welfare. We find that capital requirements can nullify the effects of financial frictions and reduce the effects of shocks emanating from the financial sector on the real economy. LTV limits, on their own, are not sufficient to constrain household indebtedness in booms, though can be used with capital requirements to keep DSRs under control. Finally, DSR limits lead to a significant decrease in the volatility of lending, consumption and inflation, since they disconnect the housing market from the real economy. Overall, DSR limits are welfare improving relative to any other macroprudential tool.

Keywords: Macroprudential policy, monetary policy, leverage ratio, affordability constraint, collateral constraint

JEL Classification: E44, E58, G21, G28

Suggested Citation

Millard, Stephen and Rubio, Margarita and Varadi, Alexandra, The Macroprudential Toolkit: Effectiveness and Interactions (January 15, 2021). Bank of England Working Paper No. 902, Available at SSRN: https://ssrn.com/abstract=3768676 or http://dx.doi.org/10.2139/ssrn.3768676

Stephen Millard (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Margarita Rubio

University of Nottingham ( email )

Alexandra Varadi

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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