The Macroprudential Toolkit: Effectiveness and Interactions

Stephen Millard, Margarita Rubio and Alexandra Varadi

Oxford Bulletin of Economics and Statistics, 2024, vol. 86, issue 2, 335-384

Abstract: We use a DSGE model with financial frictions and with macroprudential limits on both banks and mortgage borrowers, in the form of capital requirements and maximum debt‐service ratios. We then examine: (i) the impact of different combinations of macroprudential limits on key macroeconomic aggregates; (ii) their interaction with each other and with monetary policy; and (iii) their effects on the volatility of key macroeconomic variables and on welfare. We find that capital requirements on banks are the optimal tool when faced with a financial shock, as they nullify the effects of financial frictions and reduce the effects of the shock on the real economy. Instead, limits on mortgage debt‐service ratios are optimal following a housing demand shock, as they disconnect the housing market from the real economy, reducing the volatility of inflation. Hence, no policy on its own is sufficient to deal with a wide range of shocks.

Date: 2024
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https://doi.org/10.1111/obes.12582

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Working Paper: The macroprudential toolkit: effectiveness and interactions (2021)
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