A Theory of Macroprudential Policies in the Presence of Nominal Rigidities

Emmanuel Farhi and Iván Werning

No 19313, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We propose a theory of monetary policy and macroprudential interventions in financial markets. We focus on economies with nominal rigidities in goods and labor markets and subject to constraints on monetary policy, such as the zero lower bound or fixed exchange rates. We identify an aggregate demand externality that can be corrected by macroprudential interventions in financial markets. Ex post, the distribution of wealth across agents affects aggregate demand and output. Ex ante, however, these effects are not internalized in private financial decisions. We provide a simple formula for the required financial interventions that depends on a small number of measurable sufficient statistics. We also characterize optimal monetary policy. We extend our framework to incorporate pecuniary externalities, providing a unified approach to both externalities. Finally, we provide a number of applications which illustrate the relevance of our theory.

JEL-codes: D5 D6 D62 E3 E4 E5 E58 (search for similar items in EconPapers)
Date: 2013-08
New Economics Papers: this item is included in nep-mac
Note: EFG ME
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Citations: View citations in EconPapers (62)

Published as Emmanuel Farhi & Iván Werning, 2016. "A Theory of Macroprudential Policies in the Presence of Nominal Rigidities," Econometrica, Econometric Society, vol. 84, pages 1645-1704, 09.

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Journal Article: A Theory of Macroprudential Policies in the Presence of Nominal Rigidities (2016)
Working Paper: A Theory of Macroprudential Policies in the Presence of Nominal Rigidities
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