When Capital Adequacy and Interest Rate Policy Are Substitutes (And When They Are Not)
by Stephen G. Cecchettia and Marion Kohlerb
Prudential instruments are commonly seen as the tools that
can be used to deliver the macroprudential policy goals of
reducing the frequency and severity of financial crises. And
interest rates are traditionally viewed as the means to deliver
the macroeconomic stabilization goals of low, stable inflation
and sustainable, stable growth. But, at the macroeconomic
level, these two sets of policy tools have quite a bit
We use a simple macroeconomic model to study the extent
to which capital adequacy requirements and interest rates
might be substitutes in meeting the objective of stabilizing
the economy. We find that in our model these two tools are
substitutes for achieving conventional monetary policy objectives.
In addition, we show that, in principle, they can both be
used to meet financial stability objectives.
This implies a need to coordinate the use of macroprudential
and traditional monetary policy tools, a need that
has clear implications for the construction of the policy framework designed to deliver the joint objectives of macroeconomic
and financial stability.
JEL Codes: E5, G2.
Full article (PDF, 27 pages, 420 kb)
a Brandeis International Business School
b Reserve Bank of Australia