Title: Limitations of macroprudential policy and implications for monetary policy
Authors: Timo Baas - University of Duisburg-Essen (Germany)
Jeyakrishna Velauthapillai - University of Hagen (Germany) [presenting]
Helmut Wagner - University of Hagen (Germany)
Abstract: One of the main findings of the last financial crisis is that the stability of the financial system is a necessary condition for stabilising key macroeconomic variables. Since then there is an ongoing debate about the role of monetary policy in mitigating financial imbalances. Based on a two-sector DSGE model with collateralised debt, we investigate whether interest rate policy should be used to counter excessive credit and house price growth, which can lead to substantial macroeconomic costs. As a novel feature we assume that the reaction speeds of macroprudential policy and monetary policy to shocks differ, i.e. macroprudential policy is only able to respond with a time lag. We show that integrating additional financial indicators in the reaction function of the monetary policy is welfare improving, if the macroprudential policy faces the aforementioned constraint.