Optimal Monetary and Macroprudential Policies under Fire-Sale Externalities

Flora Lutz

No 2023/051, IMF Working Papers from International Monetary Fund

Abstract: I provide an integrated analysis of monetary and macroprudential policies in a model economy featuring a financial friction and a nominal wage rigidity. In this set-up, the monetary authority faces a trade-off between macroeconomic and financial stability: While expansionary counter-cyclical monetary policy prevents involuntary unemployment, it also amplifies an inefficient reallocation of capital across sectors. The main contribution of the analysis is threefold: First it highlights a novel channel through which monetary policy can impact financial stability. Second, it shows that, by itself, monetary policy can significantly mitigate the wedge between the constrained efficient and the competitive allocation. Third, regardless of the availability of macroprudential tools, stabilizing demand is usually not optimal for monetary policy.

Keywords: Monetary Policy; Macroprudential Policy; Fire-sales; Pecuniary Externalities; Unemployment; optimal Monetary; Macroprudential policies under fire sale; expansionary counter-cyclical monetary policy; bank project; fire-sale price; full employment regime; Employment; Asset prices; Monetary expansion; Liquidity; Asset liquidity (search for similar items in EconPapers)
Pages: 53
Date: 2023-03-10
New Economics Papers: this item is included in nep-cba, nep-fdg and nep-mon
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