Monetary and Macroprudential Policy Coordination with Biased Preferences
54 Pages Posted: 25 Aug 2021 Last revised: 29 Oct 2022 Publication Status: Published
Abstract
This paper studies the extent to which biased policy preferences, motivated by narrowinstitutional mandates, affect the gains from coordination between monetary policy(which may respond to financial imbalances) and macroprudential regulation (in theform of capital requirements) in responding to financial stability considerations, andwhether these mandates can be set optimally. Numerical experiments show that, dependingon the degree of bias in policy preferences, coordination may not entail burdensharing (in the sense of one policymaker reacting more, and the other less, aggressivelyto financial stability concerns) and may not be Pareto improving relative to the Nashequilibrium–even though it can generate significant gains for the economy as a whole.The optimal institutional mandate, based on maximizing household welfare under coordination,internalizes the impact of the cost of each policymaker’s own instrumentuse on policy decisions. As a result, there may be an inverse relationship between thedegree of bias in preferences and the instrument cost.
Keywords: Financial Markets and the Macroeconomy, monetary policy, Government Policy and Regulation
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