The Role of Macroprudential Policy in Times of Trouble

Jagjit S. Chadha, Germana Corrado, Luisa Corrado and Ivan De Lorenzo Buratta

Cambridge Working Papers in Economics from Faculty of Economics, University of Cambridge

Abstract: We investigate whether macroprudential policies support broader economic stability, particularly the welfare of households. For this purpose, we develop a New Keynesian business cycle model with agents subject to credit constraints and asset price fluctuations. The model differentiates between savers, who own firms and banks, and borrowers. The commercial bank sets the loan rate as a function of risk, specifically the value of housing collateral. We use occasionally binding constraints to capture nonlinearities arising from the zero lower bound (ZLB) on the policy interest rate and the borrowing constraint faced by borrower households. We examine two macroprudential tools: a countercyclical loan-to-value (LTV) ratio and a bank reserve requirement. We find that macroprudential tools significantly reduce the volatility of consumption and lending cycles and decrease both the expected frequency and severity of ZLB episodes. More generally, by attenuating the variance of the business cycle, particularly for borrower households, macroprudential tools reduce the need for monetary policy interventions.

JEL-codes: E32 E44 E51 E58 E62 (search for similar items in EconPapers)
Date: 2025-09-13
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Persistent link: https://EconPapers.repec.org/RePEc:cam:camdae:2561

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