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The Interaction of Monetary and Macroprudential Policies in Dynamic Macro Models

Sabuga, I. (2022). The Interaction of Monetary and Macroprudential Policies in Dynamic Macro Models. (Unpublished Doctoral thesis, City, University of London)


This thesis contributes to the debate on the interaction of monetary and macroprudentialpolicies in dynamic macro models, specifically using New Keynesian dynamic stochastic general equilibrium (DSGE) models.First, we propose a general equilibrium framework that highlights the interaction of reserve requirements and a conventional monetary policy in a model that combines endogenous housing loan defaults and financial intermediation frictions due to the costs of enforcing contracts. Weuse the model to examine how the interaction of these policies affect (i) the credit and business cycle; (ii) the distribution of welfare between savers and borrowers; and (iii) the overall welfare objectives when monetary and macroprudential policies are optimised together or separately. We find that models with an optimised reserve ratio rule are effective in reducing the sudden boom and bust of credit and the business cycle. We also find that there are distributive implications of the introduction of reserve ratio where borrowers gain at the expense of savers. However,there is no difference in the overall welfare results whether monetary and macroprudential policies are optimised together or separately. This chapter is co-authored with Professor Joseph Pearlman and Professor Michael Ben-Gad (both from City, University of London) and has been accepted for publication by the Economic Modelling Journal.Second, we use a DSGE framework to assess the macroeconomic effects of the output floor, anew regulatory constraint recently introduced in the Basel III framework. The main purpose of the output floor is to reduce the excessive variability of banks’ risk-weighted assets and ensure a robust level of capital requirements. Our assessment concludes that the output floor counters the downward pressures generated by modelled risk weights on risk-weighted assets and, in turn,reduces the cyclicality of capital to risks-weighted assets ratio. This contributes to mitigate the excessive expansions of credit. Our model also predicts that the output floor might trigger behavioural reactions by banks. More specifically, banks may have the incentive to shift theirportfolio from assets with a large gap between internally modelled and standardised risk weights (mortgages) to non-financial corporation loans which display a smaller gap. This chapter is co-authored with Dr. Jonathan Acosta-Smith and Dr. Marzio Bassanin (both from Bank of England). This chapter also beneffited from my PhD research internship at the Prudential Policy Directorate of the Bank of England and is due to appear as a Bank of England Staff Working Paper.Finally, the current low interest environment prompted many questions on how financial stability and the conduct of macroprudential policy should be implemented. On the onehand, low interest rate environment leads to a decrease in banks’ profitability, bank capital,and eventually bank lending, calling for a lower capital regulation. On the other hand, this environment encourages more indebtedness by borrowers and banks excessive risk taking, calling for a higher capital regulation. We study the consequences of capital regulation when the interest rate is at zero lower bound (ZLB) using a DSGE framework. We use the UK data to calibrate the parameters of the model. Our assessment concludes that the benefits of high capital regulation when the monetary policy is constrained at ZLB is greater than the model with low capital regulation. This chapter is also co-authored with Professor Joseph Pearlmanand Professor Michael Ben-Gad

Publication Type: Thesis (Doctoral)
Subjects: H Social Sciences > HB Economic Theory
Departments: Doctoral Theses
School of Policy & Global Affairs > Economics
School of Policy & Global Affairs > School of Policy & Global Affairs Doctoral Theses
[thumbnail of Doctoral Thesis_Final_Sabuga28Feb2022.pdf]
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