Dichotomy between macroprudential policy and monetary policy on credit and inflation

This paper examines the different effects of macroprudential policy and monetary policy on credit and inflation using a simple New Keynesian model with credit. In this model, macroprudential policy is effective in stabilizing credit but has a limited effect on inflation. Monetary policy with an interest rate rule stabilizes inflation, but this rule is ‘too blunt’ an instrument to stabilize credit. The determinacy of the model requires the interest rate’s response to inflation to be greater than one for one and independent of macroprudential policy. That is, the ‘Taylor principle’ applies to monetary policy. This dichotomy between macroprudential policy and monetary policy arises because each policy is designed to differently affect the saving and borrowing decisions of households.