Macro-prudential policy and the conduct of monetary policy

In this paper, we analyse the interactions between monetary and macro-prudential policies and the circumstances under which such interactions call for their coordinated implementation. We start with a review of the interdependencies between monetary and macro-prudential policies. Then, we use a dynamic stochastic general equilibrium (DSGE) model incorporating financial frictions, heterogeneous agents and housing, which is estimated for both the euro area and the United States (US) over the period 1985-2010, to identify the circumstances under which monetary and macro-prudential policies may have compounding, neutral or conflicting impacts on price stability. We compare infl ation dynamics across four “policy regimes” depending on: (a) the monetary policy objectives —that is, whether the policy instrument, the short-term interest rate factors in financial stability considerations by leaning against credit growth; and (b) the existence, or not, of an authority in charge of a financial stability objective through the implementation of macro-prudential policies that can “lean against credit” without affecting the short-term interest rate. Our main results are: (1) under most circumstances, macro-prudential policies have a limited effect on infl ation; (2) the policy regime impacts infl ation dynamics mainly in the case of financial shocks (shocks to asset prices and credit); (3) under those circumstances, the best outcome in terms of price stability is achieved by combining an independent monetary policy strictly focused on price stability and an independent macro-prudential policy leaning against credit growth; (4) the performance of this policy regime, where monetary policy and macro-prudential policies have separate assignments in terms of objectives, is improved upon if monetary policy takes into account any macro-economic effects resulting from macro-prudential policies. Finally, we assess the extent to which the new institutional arrangements adopted in Europe or proposed in the United States and the United Kingdom (UK) would effectively facilitate coordination and information-sharing between the central bank and the macro-prudential authority. Indeed, as shown in our model-based simulation, the better informed the central bank about macro-prudential policy, the more likely it is to be able to preserve price stability.