Yulin Liu (ETH Zurich): Macroprudential policy in the New Keynesian world

Yulin Liu (ETH Zurich): Macroprudential policy in the New Keynesian world

Co-authors: Hans Gersbach and Volker Hahn

 Abstract

We integrate banks and the coexistence of bank and bond financing into an otherwise standard New Keynesian Framework. Macroprudential policies in the form of varying aggregate capital requirements and interest rate policies of the central bank are used to stabilize shocks, to moderate bank credit cycles, and to induce more ecient allocation of resources across sectors. We study the interplay of these instruments. We examine how policy-making could be operationalized by second-order approximations of household welfare yielding loss for monetary and macroprudential policy-making. Finally, we investigate the optimal policy rules for monetary and macroprudential policy-makers. The optimal policy rules indicate that the central bank should focus exclusively on price stability and the macroprudential policy-maker should react to both output variation and financial instability. For the latter, the state of the credit cycle is a better indicator than direct measures of financial risk.

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