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Stabilization Policy and Boom-Bust Cycles - Monetary and Macro-Prudential Rules

  • Economics


Stabilization Policy and Boom-Bust Cycles. Monetary and Macro-Prudential Rules STABILIZATION POLICY AND BOOM-BUST CYCLES* MONETARY AND MACRO-PRUDENTIAL RULES Caterina Mendicino** | Maria Teresa Punzi*** abstract The recent fi nancial crisis has posed a challenge to the conduct of fi nancial stability and monetary policy. The international debate mainly focused on the potential benefi ts of reducing pro-cyclicality in fi nancial intermediation in order to avoid boom and bust cycles in the supply of credit. We study the stabilization benefi ts of macro-prudential and monetary policy rules that react to an indicator of fi nancial imbalances. In particular, we investigate the benefi ts of dampening credit cycles and explore the effectiveness of alternative policy instruments, such as the interest rate and the loan to value for macroeconomic and fi nancial stabilization. We fi nd that indeed it is appropriate to react to fi nancial imbalances indicators, but such reaction should preferably be undertaken by macro-prudential instruments. Should monetary policy lean against booms in asset prices and fi nancial variables? Or should fi nancial stability goals be pursued by other instruments, such as LTV ratio (LTV henceforth) ratios? The literature on asset-price movements and monetary policy mainly relies on models of exogenous bubbles, as in Bernanke and Gertler (2001) and Gilchrist and Leahy (2002). In this kind of models, the conduct of monetary policy cannot affect either the occurrence or the magnitude of boom-bust cycles in asset prices. Thus, the policy implication of these models is that the monetary authority does not need to pay attention to fi nancial developments unless fi nancial stability issues affect the outlook for infl ation. Despite the limited effect of interest-rate policies on asset price bubbles, the conduct of monetary policy might have effects on agents’ fi nancing decisions. Thus, monetary policy could have important implicatio

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