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Interaction between monetary policy and bank regulation: theory and European practice

Gerba, Eddie and Macchiarelli, Corrado (2016) Interaction between monetary policy and bank regulation: theory and European practice. Special Paper Series (10). London School of Economics and Political Science, Systemic Risk Centre, London, UK.

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Abstract

The European Union has pursued a number of initiatives to create a safer and sounder financial sector for the single market. In parallel, bold unconventional monetary policies have been implemented in order to combat low inflation, foster risk taking and, ultimately, reinvigorate growth. But monetary and macro-prudential policies interact with each other and thus may enhance or diminish the effectiveness of the other. Monetary policy affects financial stability by shaping, for instance, leverage and borrowing. Equally, macro-prudential policies constrain borrowing, which in turn have side-effects on output and prices, and therefore on monetary policy. When both monetary and macroprudential functions are housed within the central bank, coordination is improved, but safeguards are needed to counter the risks from dual objectives. Against this background, this paper outlines the theoretical and empirical underpinnings of macro-prudential policy, and discusses the way it interacts with monetary policy. We identify advantages as well as risks from cooperating in the two policy areas, and provide suggestions in terms of institutional design on how to contain those risks. Against this backdrop, we evaluate the recent European practice.

Item Type: Monograph (Discussion Paper)
Official URL: http://www.systemicrisk.ac.uk/
Additional Information: © 2016 The Authors
Divisions: Systemic Risk Centre
Subjects: H Social Sciences > HB Economic Theory
Sets: Research centres and groups > Systemic Risk Centre
Date Deposited: 23 Nov 2016 17:04
Last Modified: 29 Aug 2019 23:27
Projects: ES/K002309/1
Funders: Economic and Social Research Council
URI: http://eprints.lse.ac.uk/id/eprint/68344

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