Optimal Monetary and Macroprudential Policies

Last updated: September 2023

Monetary and macroprudential policy makers trade off financial stability and economic efficiency. This paper builds a model in which banks supply liquidity services through deposits and use them to fund loans and safe bond holdings. Expansive monetary policy can increase loan repayments but also provides liquidity to non-banks, which shifts deposit demand downward and lowers the liquidity premium of deposits. Optimally coordinated policies reveal two key complementarities over financial cycles. First, during normal times additional risk-weight add-ons for bonds are complementary to additional capital buffers. Second, during crisis times relative monetary policy tightening is complementary to releasing capital buffers.