IDEAS home Printed from https://ideas.repec.org/p/gla/glaewp/2024_12.html
   My bibliography  Save this paper

Monetary and Finacial Policy with Privately Optimal Risk Taking

Author

Listed:
  • Alfred Duncan
  • Joao Pedro De Camargo Mainente
  • Charles Nolan

Abstract

We present a model with macroprudential externalities emerging from market allocation of aggregate risks. The model predicts a paradox of safety: an increase in household risk aversion increases the volatility of output and consumption. Optimal monetary and macroprudential policies are designed to stabilise the economy whilst not exacerbating moral hazard in future periods. There is typically a macroprudential role for monetary policy, sometimes a dominant role, even when macroprudential policies are set optimally. But there are limits too. A monetary policy that focuses overly on financial stability loses control of inflation.

Suggested Citation

  • Alfred Duncan & Joao Pedro De Camargo Mainente & Charles Nolan, 2024. "Monetary and Finacial Policy with Privately Optimal Risk Taking," Working Papers 2024_12, Business School - Economics, University of Glasgow.
    • Handle: RePEc:gla:glaewp:2024_12
    as

    Download full text from publisher

    File URL: https://www.gla.ac.uk/media/Media_1120854_smxx.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Jeremy C. Stein, 2012. "Monetary Policy as Financial Stability Regulation," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 127(1), pages 57-95.
    2. Emmanuel Farhi & Iván Werning, 2016. "A Theory of Macroprudential Policies in the Presence of Nominal Rigidities," Econometrica, Econometric Society, vol. 84, pages 1645-1704, September.
    3. Duncan, Alfred J. M. & Nolan, Charles, 2019. "Disputes, debt and equity," Theoretical Economics, Econometric Society, vol. 14(3), July.
    4. Nicholas Bloom & Max Floetotto & Nir Jaimovich & Itay Saporta†Eksten & Stephen J. Terry, 2018. "Really Uncertain Business Cycles," Econometrica, Econometric Society, vol. 86(3), pages 1031-1065, May.
    5. Cristina Arellano & Yan Bai & Patrick J. Kehoe, 2019. "Financial Frictions and Fluctuations in Volatility," Journal of Political Economy, University of Chicago Press, vol. 127(5), pages 2049-2103.
    6. Cúrdia, Vasco & Woodford, Michael, 2016. "Credit Frictions and Optimal Monetary Policy," Journal of Monetary Economics, Elsevier, vol. 84(C), pages 30-65.
    7. repec:ecb:ecbdps:202218 is not listed on IDEAS
    8. Chen, Xiaoshan & Kirsanova, Tatiana & Leith, Campbell, 2017. "How optimal is US monetary policy?," Journal of Monetary Economics, Elsevier, vol. 92(C), pages 96-111.
    9. Urban Jermann & Vincenzo Quadrini, 2012. "Erratum: Macroeconomic Effects of Financial Shocks," American Economic Review, American Economic Association, vol. 102(2), pages 1186-1186, April.
    10. repec:ecb:ecbdps:202113 is not listed on IDEAS
    11. Alejandro Van der Ghote, 2021. "Interactions and Coordination between Monetary and Macroprudential Policies," American Economic Journal: Macroeconomics, American Economic Association, vol. 13(1), pages 1-34, January.
    12. Martin, Alberto & Mendicino, Caterina & Van der Ghote, Alejandro, 2021. "On the interaction between monetary and macroprudential policies," Working Paper Series 2527, European Central Bank.
    13. Anton Korinek & Alp Simsek, 2016. "Liquidity Trap and Excessive Leverage," American Economic Review, American Economic Association, vol. 106(3), pages 699-738, March.
    14. Sebastian Di Tella, 2017. "Uncertainty Shocks and Balance Sheet Recessions," Journal of Political Economy, University of Chicago Press, vol. 125(6), pages 2038-2081.
    15. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    16. Urban Jermann & Vincenzo Quadrini, 2012. "Macroeconomic Effects of Financial Shocks," American Economic Review, American Economic Association, vol. 102(1), pages 238-271, February.
    17. Laeven, Luc & Maddaloni, Angela & Mendicino, Caterina, 2022. "Monetary policy, macroprudential policy and financial stability," Working Paper Series 2647, European Central Bank.
    18. Anil K. Kashyap & Caspar Siegert, 2020. "Financial Stability Considerations and Monetary Policy," International Journal of Central Banking, International Journal of Central Banking, vol. 16(1), pages 231-266, February.
    19. Bruce C. Greenwald & Joseph E. Stiglitz, 1986. "Externalities in Economies with Imperfect Information and Incomplete Markets," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 101(2), pages 229-264.
    20. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Stijn Claessens & M Ayhan Kose, 2018. "Frontiers of macrofinancial linkages," BIS Papers, Bank for International Settlements, number 95, October –.
    2. Fendoğlu, Salih, 2014. "Optimal monetary policy rules, financial amplification, and uncertain business cycles," Journal of Economic Dynamics and Control, Elsevier, vol. 46(C), pages 271-305.
    3. Jeanne, Olivier & Korinek, Anton, 2019. "Managing credit booms and busts: A Pigouvian taxation approach," Journal of Monetary Economics, Elsevier, vol. 107(C), pages 2-17.
    4. Matthew Rognlie & Andrei Shleifer & Alp Simsek, 2018. "Investment Hangover and the Great Recession," American Economic Journal: Macroeconomics, American Economic Association, vol. 10(2), pages 113-153, April.
    5. Zaretski, Aliaksandr, 2021. "Financial constraints, risk sharing, and optimal monetary policy," MPRA Paper 110757, University Library of Munich, Germany.
    6. policy, Work stream on macroprudential & Albertazzi, Ugo & Martin, Alberto & Assouan, Emmanuelle & Tristani, Oreste & Galati, Gabriele & Vlassopoulos, Thomas, 2021. "The role of financial stability considerations in monetary policy and the interaction with macroprudential policy in the euro area," Occasional Paper Series 272, European Central Bank.
    7. Andrea Ferrero & Richard Harrison & Benjamin Nelson, 2024. "House Price Dynamics, Optimal LTV Limits and the Liquidity Trap," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 91(2), pages 940-971.
    8. Vadim Elenev & Tim Landvoigt & Stijn Van Nieuwerburgh, 2021. "A Macroeconomic Model With Financially Constrained Producers and Intermediaries," Econometrica, Econometric Society, vol. 89(3), pages 1361-1418, May.
    9. Robin Dottling, 2018. "Bank Capital Regulation in a Zero Interest Environment," Tinbergen Institute Discussion Papers 18-016/IV, Tinbergen Institute, revised 11 Oct 2019.
    10. Sebastian Di Tella & Robert E. Hall, 2020. "Risk Premium Shocks Can Create Inefficient Recessions," NBER Working Papers 26721, National Bureau of Economic Research, Inc.
    11. Freixas, Xavier & Perez-Reyna, David, 2021. "Optimal macroprudential policy and rational bubbles," Journal of Financial Intermediation, Elsevier, vol. 46(C).
    12. policy, Work stream on macroprudential & Policy, Monetary & Stability, Financial & Albertazzi, Ugo & Martin, Alberto & Assouan, Emmanuelle & Tristani, Oreste & Galati, Gabriele & Vlassopoulos, Thomas , 2023. "The role of financial stability considerations in monetary policy and the interaction with macroprudential policy in the euro area," Occasional Paper Series 272, European Central Bank.
    13. Atkeson, Andrew G. & Eisfeldt, Andrea L. & Weill, Pierre-Olivier, 2017. "Measuring the financial soundness of U.S. firms, 1926–2012," Research in Economics, Elsevier, vol. 71(3), pages 613-635.
    14. Park, Jongho, 2024. "Uncertainty shocks, equity financing, and business cycle amplifications," Journal of Corporate Finance, Elsevier, vol. 85(C).
    15. Josef Schroth, 2021. "Optimal Monetary and Macroprudential Policies," Staff Working Papers 21-21, Bank of Canada.
    16. Semyon Malamud & Andreas Schrimpf, 2016. "Intermediation Markups and Monetary Policy Passthrough," Swiss Finance Institute Research Paper Series 16-75, Swiss Finance Institute.
    17. Benhabib, Jess & Liu, Xuewen & Wang, Pengfei, 2016. "Endogenous information acquisition and countercyclical uncertainty," Journal of Economic Theory, Elsevier, vol. 165(C), pages 601-642.
    18. Alfred Duncan & Charles Nolan, 2020. "Reform of the UK Financial Policy Committee," Scottish Journal of Political Economy, Scottish Economic Society, vol. 67(1), pages 1-30, February.
    19. Joao Ayres & Gajendran Raveendranathan, 2023. "Firm Entry and Exit during Recessions," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 47, pages 47-66, January.
    20. Ansgar Walther, 2016. "Jointly Optimal Regulation of Bank Capital and Liquidity," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 48(2-3), pages 415-448, March.

    More about this item

    Keywords

    Macroeconomics; Incomplete Markets; Monetary Policy.;
    All these keywords.

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:gla:glaewp:2024_12. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Business School Research Team (email available below). General contact details of provider: https://edirc.repec.org/data/dpglauk.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.