The Interaction of Monetary and Macroprudential Policies

I analyze a New Keynesian dynamic stochastic general equilibrium (DSGE) model where the financing of productive investment is affected by a moral hazard problem. I solve for jointly Ramsey-optimal monetary and macroprudential policies. I find that when a financial friction is present in addition to the standard nominal friction, the optimal policy can replicate the first-best allocation if the social planner can conduct both monetary and macroprudential policy. Using monetary policy alone is not enough: a policy trade-off between stabilizing inflation and output gap emerges. When policy follows simple rules, the source of fluctuations is relevant for the choice of the appropriate policy mix.