Benefits of macroprudential policy in low interest rate environments
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Friday, November 11, 2022
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Short-term interest rates in the euro area and the United States
Key Points:
- Short-term interest rates in the euro area and the United States
Notes: Benchmark short-term nominal interest rate (panel A) and natural rate of return (panel B) for the euro area and the United States.
- Low levels of the natural rate for protracted periods of time pose challenges for the conduct of conventional monetary policy.
- This can happen because the ELB on nominal interest rates precludes the policy rate from tracking the natural rate if the latter falls below the bound.
- In economies with low natural rates, such as the euro area today, macroprudential policy can have benefits for the effectiveness of conventional monetary policy, in addition to safeguarding financial stability.
- The natural rate which is a risk-free, short-term real interest rate therefore increases as well.
- The above benefit points to a novel complementarity between macroprudential policy and conventional monetary policy, which takes place only in environments with low interest rates.
- If these conditions hold, macroprudential policy boosts the natural rate above the ELB, and it does so unintentionally, simply as a by-product of safeguarding financial stability.
- That is, macroprudential policy still improves the effectiveness of conventional monetary policy, but it does not allow the policy rate to accommodate aggregate demand appropriately without hitting the ELB.
- In economies with low natural rates, macroprudential policy can have benefits for the effectiveness of conventional monetary policy, in addition to safeguarding financial stability.
- These benefits arise because macroprudential policy boosts the natural rate simply as a by-product of containing systemic risk in financial markets which gives the central bank more room for stimulating aggregate demand, especially during downturns.