Monetary and Macroprudential Policies – Exploring Interactions

Abstract

This article explores the interactions between monetary policy and macroprudential policy. The starting point is that monetary policy and macroprudential policy pursue different primary objectives – price (and output) stability for monetary policy, and financial stability for macroprudential policy. Nonetheless, the conduct of each policy can have “side effects” on the objectives of the other (Figure 1). We argue that, in the presence of such side effects, effective monetary and macroprudential policies complement each other, yielding superior outcomes to a world where monetary policy – or macroprudential policy – is pursued on its own and in the absence of the other policy. In particular, we explore the following three arguments.

First, monetary policy can have a range of “side effects” on financial stability. However, macroprudential policy can attenuate these side effects, providing more room for maneuver for monetary policy to pursue its primary objective.

Second, the tightening of macroprudential policy tools can have dampening “side effects” on output. However, monetary policy can counter these effects, by adding accommodation at the margin, as long as monetary policy is effective.

Third, macroprudential policy can build buffers that can be relaxed in periods of financial stress. Such a policy can help keep open the transmission of monetary policy, preserving the effectiveness of monetary policy in the event of such stress.

For each of these three “interactions”, we also explore important empirical questions. Can macroprudential policy contain monetary side effects on financial stability effectively? How strong are the side effects of macroprudential policy on output? How effective is a relaxation of macroprudential buffers in periods of stress? This article draws on the results first reported in IMF (2013a) and IMF (2013b), and on further analysis conducted for this article on the effects of macroprudential measures for the sample of 36 countries over the period 2000−11 that was used in IMF (2013b).

Full publication: Macroprudential Policy