Will Macroprudential Policy Counteract Monetary Policy’s Effects on Financial Stability?

IMF Working Papers, December 29, 2015

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Canonical URL: Will Macroprudential Policy Counteract Monetary Policy’s Effects on Financial Stability?

Authors: Itai Agur, Maria Demertzis
Date: December 29, 2015
Core question: How does monetary policy impact upon macroprudential regulation?
Approach: A model of monetary policy transmission to bank risk taking and its interaction with a regulator's optimization problem.
Macroprudential tool analyzed: a leverage ratio used by the regulator to maintain financial stability while accounting for effects on credit provision.
Central insight: A change in the monetary policy rate tilts the regulator's entire trade-off; the regulator allows interest rate changes to partly "pass through" to bank soundness by not neutralizing the risk-taking channel of monetary policy.

The regulator does not fully neutralize the risk-taking channel of monetary policy.
Monetary policy affects financial stability even in the presence of macroprudential regulation.
The trade-off faced by the regulator includes maintaining financial stability via leverage constraints and preserving credit provision.

Macroprudential policy (via a leverage ratio) interacts with monetary policy rather than fully offsetting its effects on bank risk-taking.
Regulators may optimally permit some pass-through of monetary policy changes to banks’ risk profiles to balance stability and credit supply objectives.
Coordination considerations: The results imply that monetary policy decisions will have implications for financial stability that macroprudential policy alone will not eliminate.

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