Macroprudential Policy: Promise and Challenges

Enrique Mendoza

PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania

Abstract: Macroprudential policy holds the promise of becoming a powerful tool for preventing financial crises. Financial amplification in response to domestic shocks or global spillovers and pecuniary externalities caused by Fisherian collateral constraints provide a sound theoretical foundation for this policy. Quantitative studies show that models with these constraints replicate key stylized facts of financial crises, and that the optimal financial policy of an ideal constrained-efficient social planner reduces sharply the magnitude and frequency of crises. Research also shows, however, that implementing effective macroprudential policy still faces serious hurdles. This paper highlights three of them: (i) complexity, because the optimal policy responds widely and non-linearly to movements in both domestic factors and global spillovers due to regime shifts in global liquidity, news about global fundamentals, and recurrent innovation and regulatory changes in world markets, (ii) lack of credibility, because of time-inconsistency of the optimal policy under commitment, and (iii) coordination failure, because a careful balance with monetary policy is needed to avoid quantitatively large inefficiencies resulting from violations of Tinbergen’s rule or strategic interaction between monetary and financial authorities.

JEL-codes: E0 F0 G0 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2016-10-24, Revised 2016-10-24
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (33)

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Related works:
Chapter: Macroprudential Policy: Promise and Challenges (2018)
Working Paper: Macroprudential Policy: Promise and Challenges (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:pen:papers:16-020

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