On the limits of macroprudential policy

Abstract

This paper studies how macroprudential policy tools can complement the interest rate-based monetary policy in achieving a selection of dual stabilization objectives. We show analytically in a canonical New Keynesian model with collateral constraints that using the loan-to-value ratio as an additional policy instrument does not resolve the inflation-output volatility tradeoff. Perfect targeting of inflation and either credit or house prices with monetary and macroprudential policy is possible only if the role of credit in the economy is suffciently small. Any of these three dual stabilization objectives can be achieved with the monetary-fiscal policy mix. The identifed limits to the LTV ratio-based policy are related to its predominantly intertemporal effect on decisions made by financially constrained agents.