Monetary-macroprudential policy mix and financial system procyclicality: Should macroprudential policy be countercyclical or procyclical?

Should macroprudential policy be countercyclical or procyclical? Using an estimated medium-scale DSGE model with a wide array of shocks, we show that the optimal macroprudential (capital-requirement) response could be procyclical, in contrast to the standard recommendation of a countercyclical response. This finding is due to the existence of many shocks in the economy that imply a trade-off between achieving macroeconomic stability and financial stability. Our main, general finding on the possible desirability of a procyclical macroprudential policy response applies to any economy, even though the model for the analysis is fitted to the Indonesian economy. The only requirements are that there exists a shock that induces a trade-off between the two stability measures and that the objective of the policymakers is to maximize the welfare of economic agents. Under the scenario, the welfare loss from adopting a conventional, countercyclical macroprudential response could be sizeable.