Financial Stability and Monetary Policy: The Effects of Macroprudential Policy Instruments on the Goals of Monetary Policy and a Discussion of the Interaction of Instruments

Abstract

Throughout modern history many different approaches to financial regulation have been tried. However, as the recent financial crisis of 2007 demonstrated, the existing rules and regulations were not enough to prevent a financial crash. The crisis spurred new thinking and one outcome was the idea of a broader use of time-varying macroprudential policy. The experience of many of these new policies is limited. However, since many of the proposed policy measures affects the credit market, it is not unlikely that some of the measures may slow down economic growth. Of the same reason, the question of whether these new policy measures have an effect on the efficiency of monetary policy has been posed. This thesis is an extensive review of much of the literature concerning macropruden- tial policy with a special consideration to the literature concerning its interaction with monetary policy. Using a discussion between Lars Svensson and Michael Wood- ford as a backdrop, two different proposals onto how to best address systemic risk is discussed. Their discussion serves as a basis for an analysis of many of the issues addressed in the literature. Until more empirical results about the effects of macroprudential policy is presented, it is difficult to make clear suggestions about how best to coordinate macroprudential and monetary policy. The term "macroprudential" must be concretized and more empirical results on the extent to which macroprudential instruments affects the efficiency of monetary policy is needed. If these results were to indicate that macro- prudential policy does interact with monetary policy, some form of coordination of policy may be appropriate.

Throughout modern history many different approaches to financial regulation have been tried. However, as the recent financial crisis of 2007 demonstrated, the existing rules and regulations were not enough to prevent a financial crash. The crisis spurred new thinking and one outcome was the idea of a broader use of time-varying macroprudential policy. The experience of many of these new policies is limited. However, since many of the proposed policy measures affects the credit market, it is not unlikely that some of the measures may slow down economic growth. Of the same reason, the question of whether these new policy measures have an effect on the efficiency of monetary policy has been posed. This thesis is an extensive review of much of the literature concerning macropruden- tial policy with a special consideration to the literature concerning its interaction with monetary policy. Using a discussion between Lars Svensson and Michael Wood- ford as a backdrop, two different proposals onto how to best address systemic risk is discussed. Their discussion serves as a basis for an analysis of many of the issues addressed in the literature. Until more empirical results about the effects of macroprudential policy is presented, it is difficult to make clear suggestions about how best to coordinate macroprudential and monetary policy. The term "macroprudential" must be concretized and more empirical results on the extent to which macroprudential instruments affects the efficiency of monetary policy is needed. If these results were to indicate that macro- prudential policy does interact with monetary policy, some form of coordination of policy may be appropriate.