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Capital Regulation, Monetary Policy and Financial Stability

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  • Pierre-Richard Agénor
  • Koray Alper
  • Luiz Pereira da Silva

Abstract

This paper examines the roles of bank capital regulation and monetary policy in mitigating procyclicality and promoting macroeconomic and financial stability. The analysis is based on a dynamic stochastic model with imperfect credit markets. Macroeconomic (financial) stability is defined in terms of the volatility of nominal income (real house prices). Numerical experiments show that even if monetary policy can react strongly to inflation deviations from target, combining a credit-augmented interest rate rule and a Basel III-type countercyclical capital regulatory rule may be optimal for promoting overall economic stability. The greater the degree of interest rate smoothing, and the stronger the policymaker's concern with macroeconomic stability, the larger is the sensitivity of the regulatory rule to credit growth gaps.

Suggested Citation

  • Pierre-Richard Agénor & Koray Alper & Luiz Pereira da Silva, 2011. "Capital Regulation, Monetary Policy and Financial Stability," Centre for Growth and Business Cycle Research Discussion Paper Series 154, Economics, The University of Manchester.
    • Handle: RePEc:man:cgbcrp:154
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    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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