When Could Macroprudential and Monetary Policies Be in Conflict?

Abstract

This paper aims to provide a comprehensive analysis of the potential conflicts between macroprudential and monetary policies within a DGSE model with financial frictions. The identification of conflicts is conditional on different types of shocks, different policy instruments, and different policy objectives (variance of key variables, probability of a crisis, growth-at-risk). We first find that conflicts are not systematic but are fairly frequent, especially in the case of supply-side and widespread shocks such as technology and bank capital shocks. Second, monetary policy and countercyclical capital requirements generate conflicts in many circumstances. By affecting interest rates, they both “get in all the cracks”, albeit with their respective targets generally moving in opposite directions. Nonetheless, monetary policy could reduce its adverse financial side effects by responding strongly to the output gap. Third, loan-to-value caps, as sector-specific instruments, cause few conflicts. Thus, they can be easily implemented without concerns about generating potential spillovers, whereas smooth coordination is required between the implementation of capital requirements and of monetary policy.