Coordinating monetary and macroprudential policies

De Paoli, Bianca; Paustian, Matthias

Report

Coordinating monetary and macroprudential policies

Abstract: The financial crisis has prompted macroeconomists to think of new policy instruments that could help ensure financial stability. Policymakers are interested in understanding how these should be set in conjunction with monetary policy. We contribute to this debate by analyzing how monetary and macroprudential policy should be conducted to reduce the costs of macroeconomic fluctuations. We do so in a model in which such costs are driven by nominal rigidities and credit constraints. We find that, if faced with cost-push shocks, policy authorities should cooperate and commit to a given course of action. In a world in which monetary and macroprudential tools are set independently and under discretion, our findings suggest that assigning conservative mandates ( la Rogoff [1985]) and having one of the authorities act as a leader can mitigate coordination problems. At the same time, choosing monetary and macroprudential tools that work in a similar fashion can increase such problems.

Keywords: commitment; policy coordination; borrowing constraints; discretion; monetary policy; macroprudential policy;

JEL Classification: E32; C32;