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Monetary-macroprudential policy mix and financial system procyclicality: Should macroprudential policy be countercyclical or procyclical?

Author

Listed:
  • Solikin M. Juhro
  • Denny Lie
Abstract
Should macroprudential policy be countercyclical or procyclical? Using an estimated medium-scale DSGE model with a wide array of shocks, we show that the optimal macroprudential (capital-requirement) response could be procyclical, in contrast to the standard recommendation of a countercyclical response. This finding is due to the existence of many shocks in the economy that imply a trade-off between achieving macroeconomic stability and financial stability. Our main, general finding on the possible desirability of a procyclical macroprudential policy response applies to any economy, even though the model for the analysis is fitted to the Indonesian economy. The only requirements are that there exists a shock that induces a trade-off between the two stability measures and that the objective of the policymakers is to maximize the welfare of economic agents. Under the scenario, the welfare loss from adopting a conventional, countercyclical macroprudential response could be sizeable.

Suggested Citation

  • Solikin M. Juhro & Denny Lie, 2024. "Monetary-macroprudential policy mix and financial system procyclicality: Should macroprudential policy be countercyclical or procyclical?," Working Papers 2024-22, University of Sydney, School of Economics.
    • Handle: RePEc:syd:wpaper:2024-22
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    References listed on IDEAS

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    Keywords

    monetary policy; macroprudential policy; policy mix; financial system procyclicality; capital requirement; countercyclical or procyclical policy;
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