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The interaction between monetary and macroprudential policy: Should central banks "lean against the wind" to foster macrofinancial stability?

Sebastian Krug ()

No 2015-08, Economics Working Papers from Christian-Albrechts-University of Kiel, Department of Economics

Abstract: The extensive harm caused by the financial crisis raises the question of whether policymakers could have done more to prevent the build-up of financial imbalances. This paper aims to contribute to the field of regulatory impact assessment by taking up the revived debate on whether central banks should "lean against the wind" or not. Currently, there is no consensus on whether monetary policy is, in general, able to support the resilience of the financial system or if this task should better be left to the macroprudential approach of financial regulation. We aim to shed light on this issue by analyzing distinct policy regimes within an agent-based computational macro-model with endogenous money. We find that policies make use of their comparative advantage leading to superior outcomes concerning their respective intended objectives. In particular, we show that "leaning against the wind" should only serve as first line of defense in the absence of a prudential regulatory regime and that price stability does not necessarily mean financial stability. Moreover, macroprudential regulation as unburdened policy instrument is able to dampen the build-up of financial imbalances by restricting credit to the unsustainable high-leveraged part of the real economy. In contrast, leaning against the wind seems to have no positive impact on financial stability which strengthens proponents of Tinbergen's principle arguing that both policies are designed for their specific purpose and that they should be used accordingly.

Keywords: Financial Stability; Monetary Economics; Macroprudential Policy; Financial Regulation; Central Banking; Agent-Based Macroeconomics (search for similar items in EconPapers)
JEL-codes: E44 E50 G01 G28 C63 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
Date: 2015
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Working Paper: The interaction between monetary and macroprudential policy: Should central banks "lean against the wind" to foster macro-financial stability? (2017) Downloads
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