Monetary and Macroprudential Policy Rules in a Model with House Price Booms

IMF Working Papers, November 1, 2009

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Authors: Alasdair Scott, Pau Rabanal, Prakash Kannan
Date: November 1, 2009
Core argument: A stronger emphasis on macrofinancial risk could provide stabilization benefits.
Key simulation insight: Strong monetary reactions to accelerator mechanisms that push up credit growth and asset prices could help macroeconomic stability.
Complementary policy tool: A macroprudential instrument designed specifically to dampen credit market cycles would also be useful.
Caution: Invariant and rigid policy responses raise the risk of policy errors that could lower, not raise, macroeconomic stability; hence, discretion would be required.

Emphasizing macrofinancial risk in policy frameworks can improve stabilization outcomes.
Monetary policy that reacts strongly to accelerator mechanisms (those that boost credit growth and asset prices) can contribute to macroeconomic stability.
Macroprudential instruments targeted at credit market cycles provide additional usefulness in stabilizing the economy.
Rigid, rule-based policy responses risk producing policy errors and reducing macroeconomic stability; discretionary judgment is necessary.

Consider stronger monetary policy reactions to indicators of credit growth and asset price accelerations.
Implement a macroprudential instrument aimed at damping credit market cycles alongside monetary policy.
Avoid invariant, mechanically rigid policy rules; maintain discretionary capacity to respond to evolving macrofinancial conditions.