Interactions between monetary and macroprudential policies

This article reviews the potential tensions between monetary and macroprudential policies and tries to quantitatively evaluate their importance. Both types of policies have overlapping transmission mechanisms, since they primarily work through the financial system. One policy shapes the playing field of the other. Thus, the effects of one policy need to be considered in the conception and implementation of the other, very much the same way as policy makers already take into account other structural economic features that affect the level and composition of output. In order to evaluate how quantitatively important these interactions are we simulate a dynamic stochastic general equilibrium model that we calibrate to euro area data. The model encompasses, among others, financial frictions that manifest themselves as a collateral constraint. Macroprudential policy is modeled as a countercyclical variation in the intensity of the latter. We embed three macroeconomic shocks that illustrate the key propagation and amplification mechanisms of the Great Recession. Finally, we explicitly consider the zero lower bound (ZLB) on nominal interest rates. Given this set-up, our main findings are: • macroprudential policies act as a useful complement to monetary policy during crises, by attenuating the decrease in investment and, hence, output; • forward guidance is very effective at the ZLB, by providing a substantial boost to demand and reducing the costs of private deleveraging at the same time; • overall, countercyclical macroprudential policies do not undo the benefits of forward guidance, but rather sustain them.