Combining monetary and macroprudential policies to promote macroeconomic and financial stability

Since the global financial crisis (GFC) of 2007-2008, interactions between monetary and macroprudential policies, and the extent to which these policies should be combined to promote macroeconomic and financial stability, have been key issues for central banks around the world. Prof. Agénor of Manchester led a wide-ranging research agenda on these issues.

The GFC made it abundantly clear that financial regulation must focus on the financial system as a whole (a 'macroprudential' perspective), rather than individual financial institutions (the traditional 'microprudential' view) to identify weaknesses in the financial sector and mitigate risks to the economy. It also became clear that macroeconomic stability and financial stability are fundamentally linked, making it critical to understand how monetary and macroprudential policies interact, and how they should be combined to achieve both objectives.

The research underpinning this case study focused on the development of theoretical and quantitative macroeconomic models to study how monetary and macroprudential policies interact, and how these policies should be combined to promote macroeconomic and financial stability. This research was undertaken in direct collaboration with several central banks (e.g., Brazil and Turkey) and a leading international financial institution (the Bank for International Settlements).

This research, based on cutting-edge analytical and numerical methods in macroeconomics, focussed on (i) previously unaddressed modelling issues related to the transmission mechanisms of monetary and macroprudential policies; (ii) interactions between these policies; and (iii) specific policy challenges facing middle-income countries (MICs), such as building and maintaining credibility, and managing large capital inflows.

It has led to a range of technical contributions, related to the performance of monetary and macroprudential policy rules in macroeconomic models, and how these models should be used to calibrate joint policy responses. In addition, it has brought new insights on the post-GFC design of macroeconomic policy frameworks in MICs, especially as it relates to institutional reforms on policy delegation.

Evidence of impact relates to the three dimensions in which the research brought new results and insights

A) a better understanding of the transmission mechanisms of monetary and macroprudential policies, and how these policies interact;

B) practical guidance on how policies should be calibrated to promote macroeconomic and financial stability;

C) the design of macroeconomic policy frameworks in the post-GFC world, especially as it relates to institutional policy delegation and the combination of short-term policy instruments.

The impact described under (A) and (B) was achieved through training activities, which covered both theoretical and practical modelling aspects related to the transmission and combination of monetary and macroprudential policies.

The impact described under (C) was achieved through participation by Prof. Agénor and some of his collaborators, including Dr. Neanidis, to high-level policy-oriented seminars and conferences, during which research outputs were presented. These activities included presentations in central banks, international organizations (Bank for International Settlements, European Central Bank, Inter-American Development Bank, International Monetary Fund, OECD, World Bank), and other venues, including meetings of the G20 Central Banks.