Policy mandates for macro-prudential and monetary policies in a new Keynesian framework

Paul Levine () and Diana Lima

No 1784, Working Paper Series from European Central Bank

Abstract: In the aftermath of the financial crisis, the role of monetary policy and macro-prudential regulation in promoting financial stability is under discussion. The old debate concerning whether monetary policy should respond to credit and asset price bubbles was revived, whereas macro-prudential regulation is being assessed as an alternative macroeconomic tool to deal with financial imbalances. The paper explores both sides of the debate in a New Keynesian framework with financial frictions by comparing the welfare and stabilisation impacts of distinct policy regimes. First, we investigate whether there is a welfare benefit from monetary policy leaning against financial instability. We show that monetary policy rules of this type perform better than conventional monetary rules. Second, by introducing macro-prudential regulation in the model, results from optimal policy analysis suggest also that there are welfare gains, even in the case in which monetary and macro-prudential authorities are independent and react to their own policy goal. JEL Classification: E30, E50, G28

Keywords: DSGE; financial frictions; macro-prudential policy; monetary policy (search for similar items in EconPapers)
Date: 2015-04
New Economics Papers: this item is included in nep-ban, nep-cba, nep-dge and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (20)

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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20151784

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