Capital Regulation, Monetary Policy and Financial Stability

Capital Regulation, Monetary Policy and Financial Stability

Title : Capital Regulation, Monetary Policy and Financial Stability
Number : 12/28
Author(s) : P.-R. Agénor, K. Alper, and L. Pereira da Silva
Language : English
Date : October 2012
Abstract : This paper examines the roles of bank capital regulation and monetary policy in mitigating procyclicality and promoting macroeconomic and financial stability. The analysis is based on a dynamic stochastic model with imperfect credit markets. Macroeconomic stability is defined in terms of a weighted average of inflation and output gap volatility, whereas financial stability is defined in terms of three alternative indicators (real house prices, the credit-to-GDP ratio, and the loan spread), both individually and in combination. Numerical experiments associated with a housing demand shock show that in a number of cases, even if monetary policy can react strongly to inflation deviations from target, combining a credit-augmented interest rate rule and a Basel III-type countercyclical capital regulatory rule may be optimal for promoting overall economic stability. The greater the degree of policy interest rate smoothing, and the stronger the policymaker’s concern with financial stability, the larger is the sensitivity of the regulatory rule to credit growth gaps.
Keywords : Financial Stability, Credit, Monetary Policy
JEL Codes : E44; E51

 

Capital Regulation, Monetary Policy and Financial Stability
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