Optimal Macroprudential Policy
This paper introduces financial market frictions into a standard New Keynesian model through search and matching in the credit market. Under such financial market frictions, a second-order approximation of social welfare includes a term involving credit, in addition to terms for inflation and consumption. As a consequence, the optimal monetary and macroprudential policies must contribute to both financial and price stability. This result holds for various approximated welfares that can change corresponding to macroprudential policy variables. The key features of optimal policies are as follows. The optimal monetary policy requires keeping the credit market countercyclical against the real economy. Commitment in monetary and macroprudential policy, rather than approximated welfare, justifies history dependence and pre-emptiveness. Appropriate combinations of macroprudential and monetary policy achieve perfect financial and price stability.
The serious economic disruptions caused by financial crises reveal the critical roles played by financial markets in the U.S. and the Euro area. Acknowledging that the current policy framework cannot fully mitigate nor avoid financial crises, policymakers have begun to shed light on two policy measures. The first is monetary policy, which aims to achieve, in addition to traditional policy goals, stability of the financial system. The second is a new policy tool, macroprudential policy geared toward financial stability.