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Combining monetary policy and prudential regulation: an agent-based modeling approach

Michel Alexandre () and Gilberto Lima ()
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Michel Alexandre: Central Bank of Brazil

Journal of Economic Interaction and Coordination, 2020, vol. 15, issue 2, No 3, 385-411

Abstract: Abstract This paper explores the interaction between monetary policy and prudential regulation in an agent-based modeling framework. Firms borrow funds from the banking system in an economy regulated by a central bank. The central bank carries out monetary policy, by setting the interest rate, and prudential regulation, by establishing the banking capital requirement. Different combinations of interest rate rule and capital requirement rule are evaluated with respect to both macroeconomic and financial stability. Several relevant policy implications were drawn. First, the efficacy of a given capital requirement rule or interest rate rule depends on the specification of the rule of the other type it is combined with. More precisely, less aggressive interest rate rules perform better when the range of variation of the capital requirement is narrower. Second, interest rate smoothing is more effective than the other interest rate rules assessed, as it outperforms those other rules with respect to financial stability and macroeconomic stability. Third, there is no tradeoff between financial and macroeconomic stability associated with a variation of either the capital requirement or the smoothing interest rate parameter. Finally, our results reinforce the cautionary finding of other studies regarding how output can be ravaged by a low inflation targeting.

Keywords: Agent-based modeling; Monetary policy; Financial stability; Prudential regulation (search for similar items in EconPapers)
JEL-codes: E52 G18 C63 (search for similar items in EconPapers)
Date: 2020
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Related works:
Working Paper: Combining Monetary Policy and Prudential Regulation: An Agent-Based Modeling Approach (2017) Downloads
Working Paper: COMBINING MONETARY POLICY AND PRUDENTIAL REGULATION: AN AGENT-BASED MODELING APPROACH (2016) Downloads
Working Paper: Combining Monetary Policy and Prudential Regulation: an agent-based modeling approach (2015) Downloads
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DOI: 10.1007/s11403-017-0209-0

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