The interdependence of monetary and macroprudential policy under the zero lower bound. National Bank of Belgium Working Paper No. 310

Lewis, Vivien and Villa, Stefania (2016) The interdependence of monetary and macroprudential policy under the zero lower bound. National Bank of Belgium Working Paper No. 310. [Working Paper]

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Abstract

This paper considers the interdependence of interest rate rules and macroprudential policies in a New Keynesian business cycle model, where entrepreneurs and banks engage in a loan contract and both are subject to idiosyncratic default risk. We analyze the transmission of firm and bank risk as well as TFP shocks under the zero lower bound (ZLB) and different macroprudential policy coefficients. The ZLB constraint exacerbates the fall in GDP in response to the firm risk shock but not to the bank risk shock, which acts as a supply shock. From a policy perspective, a bolder responsiveness of the capital requirement instrument mitigates the recession in response to bank/firm risk shocks since it reduces the probability of bank/firm default, respectively.

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