Monetary Policy and Macroprudential Policy: New Evidence from a World Panel of Countries

DOIhttp://doi.org/10.1111/obes.12182
Date01 June 2017
Published date01 June 2017
AuthorNicholas Apergis
395
©2017 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd.
OXFORD BULLETIN OF ECONOMICSAND STATISTICS, 79, 3 (2017) 0305–9049
doi: 10.1111/obes.12182
Monetary Policy and Macroprudential Policy: New
Evidence from a World Panel of Countries*
Nicholas Apergis
Department of Banking & Financial Management, University of Piraeus, Piraeus, Attica,
Greece (e-mail: napergis@unipi.gr)
Abstract
The event of the recent financial crisis raises the question of whether policy makers could
have done more or something different to prevent the build-up of financial imbalances.
This paper contributes to the field of regulatory impact by tackling the debate on whether
central banks should ‘lean against the wind’, while in case the response is positive, how
macroprudential policies should be combined with monetary policy. Using an augmented
Taylor rule and a sample of 127 global economies, the results provide evidence on the
importance of macroprudential issues for the implementation of an effective monetary
policy. They also document that the type of adopted macroprudential instrument has a
substantial effect on such effectiveness, with this policy mix being less ‘integrated’ when
the monetary rule aims at primarily safeguarding inflation stability. The results survive
robustness checks under alternative assets.
I. Introduction
The goal of this paper is to study the policy mix between monetary and macroprudential
policy. More specifically, it explores the role of macroprudential policies through an aug-
mented Taylor policy rule that explicitly considers not only inflation and the output gap,
but also the financial gap, that is, whether the combined actions of monetary and macro-
prudential policies are considered a complementarity, so as to preserve financial stability.
The methodology,after estimating individual (augmented) Taylor rules for 127 global coun-
tries, considers the coefficient response to the financial gap as an explanatory variable that
is representative of the relationship between this policy mix.The novelties of this work are
threefold: (i) the empirical analysis generates estimations of augmented Taylor rules for
economies that were never before part of the empirical literature, (ii) new evidence on the
combined role of monetary and macroprudential policies that ensures overall economic
stability is provided,and (iii) new evidence on incorporating the housing market, given that
JEL Classification numbers: E52, E60, G28
*The author needs to thank two referees of this journal whose comments and suggestions immensely improved
the merit of this work. Special thanks also go to the Editor for giving him the chance to revise his work.Needless to
say, the usual disclaimer applies.
396 Bulletin
asset prices contain information about future inflation, while certain central banks directly
try to offset any disequilibria issues in these markets.
Macroprudential policies, that is, caps on loan-to-value and debt-to-income ratios,
limits on credit growth, balance sheet restrictions, capital and reserve requirements, are of
primary concern to reduce systemic risks in financial markets. While emerging markets
have used them extensively, advanced economies have started only recentlyto adopt them.
A growing literature has documented the use of these policies across countries and analysed
their effects (Freixas,Laeven and Peydr´o, 2015; Claessens, 2015). In a recent paper, Cerutti,
Claessens and Laeven (2016) document the use of macroprudential policies for a large
number of countries, while covering many instruments. They provide evidence on which
policies have been most effective in terms of reducing the growth of credit, covering both
household and corporate sector credit, while exploring differences among types of countries
(i.e. advanced versus emerging), and whether policies work better in different phases of
the financial cycle. Macroprudential policies should be coordinated with monetary policy
to ensure not only the target of price (primarily) and output stability, but also that of
financial stability. However, a critical question is whether monetary policy should be more
‘lean’. A number of studies have recommended that augmenting the Taylor rule (1993)
with a financial target to allow the interest rate to react to financial stress was the first way
researchers and policy makers considered to highlight the end of the so-called ‘separation
principle’ (Christiano et al., 2010; Curdia and Woodford, 2010; Issing, 2011). It has been
also the event of the recent financial crisis that has shifted the strategic considerations about
monetary policy and weakened the strategy of ‘cleaning up afterwards’. The presence of
macroprudential instruments has radically heated the debate ‘clean’ versus ‘lean’. The
supporters of the augmented Taylor rule are in favour that policy makers need as many
instruments as targets. Hence, if interest rates cannot do everything alone, potentially they
can be complements to macroprudential instruments, and can provide coordination between
monetary and macroprudential policies. Interest rates primarily target monetary stability,
while they act timelyon financial stability as complements to macropr udential instruments,
giving support to the integrated approach in which monetary and financial stability are
integrated into an ‘augmented’Taylor rule. In contrast, the separate approach of the policy-
mix does not consider that the interest rate can ever respond to financial stability, while the
macroprudential policy is targeting financial stability.Within the relevant literature,Adrian
and Shin (2009), Mishkin (2011) and Eichengreen et al. (2011) intensively advocate the
integrated approach of the policy mix between monetary and macroprudential policies.
The argument in favour of the role of the interest rate in financial regulation is that under
an augmented Taylor rule, not only banks, but also the whole financial system, experience
financial imbalances, while there is inadequate supportive evidence for the effectiveness of
macroprudential instruments (Ag´enor and Pereira Da Silva, 2013). By contrast, Svensson
(2012) supports the separate approach, while he is against the effectiveness of interest
rates to guarantee financial instability. In certain circumstances, such as the 2008 financial
crisis, monetary policy may deviate from its traditional objectives to support financial
stability.
However, monetary policy, if left alone, may fail to ensure financial stability, poten-
tially when its credibility may suffer because (i) crises will most likely occur despite lean-
ing against the wind, and (ii) the central bank under delivers on inflation, and thus could
©2017 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd

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