There is an increasing concern among policy makers and economists about macro prudential policies that aim to stabilize the economy and alleviate financial distortions through affecting output and inflation levels . This paper by Claessens, and Valencia, (2013) at VOX tries to study the possible interactions between monetary and macro prudential policies. In addition, it highlights the stylized fact that neither monetary nor fiscal policies are sufficient to stabilize the economy, additional tool is needed to continue this job.
“The newly emerging paradigm is one in which both monetary policy and macro prudential policies are used for counter cyclical management: monetary policy primarily aimed at price stability; and macro prudential policies primarily aimed at financial stability. But these policies interact with each other and thus each may enhance or diminish the effectiveness of the other”
When prices rigidities are the only distortion, then momentary policy goal of stabilizing prices will also stabilize output and maximize welfare, but in the presence of financial market imperfections, which affect people expectations and predicted risks, this will hinder the influence of monetary policy on output stabilization. If this is the case, then monetary policy is not enough, because financial distortions might not directly/indirectly be related to liquidity levels. A combination of both monetary and macroprudential policies -with one focusing on liquidity and other focusing on altering aggregate demand of this liquidity- to reduce financial risks and stabilize the economy is required.
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