The Interaction of Monetary and Macroprudential Policies in Economic Stabilisation

Abstract

I analyse the dynamics of a New Keynesian DSGE model where the financing of investments is affected by a moral hazard problem. I solve for jointly Ramsey-optimal monetary and macroprudential policies. I find that when a financial friction is present in addition to the standard nominal friction, the optimal policy can replicate the first-best if the social planner can conduct both monetary and macroprudential policy to control both inflation and the level of investments. Using monetary policy alone is not enough to fully stabilise the economy: it leads to a policy trade-off between stabilising inflation and the output gap. When policy follows simple rules instead, the source of fluctuations is highly relevant for the choice of the appropriate policy mix.