Macroprudential and Monetary Policies: Implications for Financial Stability and Welfare

By José Carrasco-Gallego and Margarita Rubio

In this paper, we analyse the implications of macroprudential and monetary policies for business cycles, welfare, and .nancial stability. We consider a dynamic stochastic general equilibrium (DSGE) model with housing and collateral constraints. A macroprudential rule on the loan-to-value ratio (LTV), which responds to output and house price deviations, interacts with a traditional Taylor rule for monetary policy. From a positive perspective, introducing a macroprudential tool mitigates the effects of booms in the economy by restricting credit. However, monetary and macroprudential policies may enter in conflict when shocks come from the supply-side of the economy. From a normative point of view, results show that the introduction of this macroprudential measure is welfare improving. Then, we calculate the combination of policy parameters that maximizes welfare and find that the optimal LTV rule should respond relatively more aggressively to house prices than to output deviations. Finally, we study the efficiency of the policy mix. We propose a tool that includes not only the variability of output and inflation but also the variability of borrowing, to capture the effects of policies on financial stability: a three-dimensional policy frontier (3DPF). We find that both policies acting together unambiguously improve the stability of the system.

As much as capital requirements for banks should vary over the business cycle, this paper argues that the loan-to-value ratio for commercial loans should also be a policy variable. That makes good sense if it were otherwise constant, as it is admittedly often modelled. But lenders do adjust it according to circumstances, and the question therefore should be whether there is still room for a policy-maker to intervene and adjust it in its own way. Due to moral hazard in the banking sector, a strong point for intervention can be made for capital requirements. I am not sure where the market inefficiency would be that would call for intervention on the loan-to-value ratio.

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