The Relationship Between Monetary and Macroprudential Policies

Kang, Jong Ku

  • 2007 ITEM VIEW
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This paper analyzes the interaction between monetary and

macroprudential policies mainly in the context of the non-cooperation

among policy authorities. Each policy authority’s optimal response is

to tighten its policy measures when other authorities’ policy measures

are loosened. This indicates that the two policies are substitutes for

each other. This result still holds when an additional financial stability

mandate is assigned to the central bank. The condition for the

response functions to converge to a Nash equilibrium state is analyzed

along with the speed of convergence, showing that they depend on the

authorities’ preferences and the number of mandates assigned to

policy authorities. If the financial supervisory authority (FSA) assigns

greater importance to the output gap or a stronger financial stability

mandate is assigned to the central bank (CB), the probability of nonconvergence

increases and the speed of convergence declines even

when the condition of convergence is satisfied. Meanwhile, if the CB

considers output stability as an important task, the probability of

convergence and the speed of converging to a state of equilibrium are

high. Finally, when a single mandate or small number of mandates

is/are assigned to each authority, stability is more quickly restored as

compared to when many mandates are assigned.

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