Optimal Monetary and Macroprudential Policies under Fire-Sale Externalities
IMF Working Papers, March 10, 2023
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- Optimal Monetary and Macroprudential Policies under Fire-Sale Externalities
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Bibliographic details
- Authors: Flora Lutz
- Published: March 10, 2023
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9798400235191.001
Summary and research question
- Integrated analysis of monetary and macroprudential policies in a model economy featuring a financial friction and a nominal wage rigidity.
- Central trade-off for the monetary authority: expansionary counter-cyclical monetary policy prevents involuntary unemployment but amplifies an inefficient reallocation of capital across sectors.
- Research explores how monetary policy and macroprudential tools interact when fire-sale externalities and nominal wage rigidity are present.
Main contributions and findings
- Highlights a novel channel through which monetary policy can impact financial stability.
- Shows that, by itself, monetary policy can significantly mitigate the wedge between the constrained efficient and the competitive allocation.
- Demonstrates that, regardless of the availability of macroprudential tools, stabilizing demand is usually not optimal for monetary policy.
- Emphasizes the role of expansionary counter-cyclical monetary policy in both preventing unemployment and amplifying inefficient capital reallocation.
Policy implications and recommendations
- Monetary policy cannot be evaluated solely on demand stabilization grounds when fire-sale externalities and nominal wage rigidity are present.
- Optimal policy requires weighing macroeconomic stabilization against financial-stability externalities arising from asset reallocation and fire-sales.
- Macroprudential tools interact with monetary policy but do not eliminate the finding that stabilizing demand is usually suboptimal for monetary policy.
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