Policy mandates for macro-prudential and monetary policies in a new Keynesian framework

In the aftermath of the nancial crisis, the role of monetary policy and macro-prudential regulation in promoting nancial stability is under discussion. The old debate concerning whether monetary policy should respond to credit and asset price bubbles was revived, whereas macro-prudential regulation is being assessed as an alternative macroeconomic tool to deal with nancial imbalances. The paper explores both sides of the debate in a New Keynesian framework with nancial frictions by comparing the welfare and stabilisation impacts of distinct policy regimes. First, we investigate whether there is a welfare bene t from monetary policy leaning against nancial instability. We show that monetary policy rules of this type perform better than conventional monetary rules. Second, by introducing macro-prudential regulation in the model, results from optimal policy analysis suggest also that there are welfare gains, even in the case in which monetary and macro-prudential authorities are independent and react to their own policy goal. JEL classi cation: E30, E50, G28.