Monetary and Macroprudential Policy in an Estimated DSGE Model of the Euro Area

Abstract

In this paper, we study the optimal mix of monetary and macroprudential policies in an estimated two-country model of the euro area. The model includes real, nominal and financial frictions, and hence both monetary and macroprudential policy can play a role. Wefind that the introduction of a macroprudential rule would help in reducing macroeconomic volatility, improve welfare, and partially substitute for the lack of national monetary policies. Macroprudential policy would always increase the welfare of savers, but their effects on borrowers depend on the shock that hits the economy. In particular, macroprudential policy may entail welfare costs for borrowers under technology shocks, by increasing the countercyclical behavior of lending spreads.

Keywords: Monetary policy, Euro Area, European Economic and Monetary Union, Macroprudential Policy, Credit expansion, Economic models, EMU, Basel III, Financial Frictions., standard deviation, interest rates, central bank, real variables, business cycle, macroeconomic volatility, output growth, consumption growth, macroeconomic variables, financial sector, financial system, price stability, international monetary fund, real output, private consumption, budget constraint, capital inflows, central banks, real exchange, capital flows, real exchange rate, real interest rates, asymmetric information, monetary policy rule, inflation rates, financial systems, economic policy, monetary shocks, balance sheets,

JEL Classification: C51, E44, E52