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Interaction between monetary policy and bank regulation: theory and European practice

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  • Gerba, Eddie
  • Macchiarelli, Corrado

Abstract

The European Union has pursued a number of initiatives to create a safer and sounder financial sector for the single market. In parallel, bold unconventional monetary policies have been implemented in order to combat low inflation, foster risk taking and, ultimately, reinvigorate growth. But monetary and macro-prudential policies interact with each other and thus may enhance or diminish the effectiveness of the other. Monetary policy affects financial stability by shaping, for instance, leverage and borrowing. Equally, macro-prudential policies constrain borrowing, which in turn have side-effects on output and prices, and therefore on monetary policy. When both monetary and macroprudential functions are housed within the central bank, coordination is improved, but safeguards are needed to counter the risks from dual objectives. Against this background, this paper outlines the theoretical and empirical underpinnings of macro-prudential policy, and discusses the way it interacts with monetary policy. We identify advantages as well as risks from cooperating in the two policy areas, and provide suggestions in terms of institutional design on how to contain those risks. Against this backdrop, we evaluate the recent European practice.

Suggested Citation

  • Gerba, Eddie & Macchiarelli, Corrado, 2016. "Interaction between monetary policy and bank regulation: theory and European practice," LSE Research Online Documents on Economics 68344, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:68344
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    File URL: http://eprints.lse.ac.uk/68344/
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    References listed on IDEAS

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    Cited by:

    1. Corrado Macchiarelli, 2018. "What is the EU-UK relation all about? Tracking the path from monetary integration to “ever closeness”," LEQS – LSE 'Europe in Question' Discussion Paper Series 137, European Institute, LSE.

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