Optimal Macroprudential Policy

This paper introduces financial market frictions into a standard New Keynesian model through search and matching in the credit market. Under such financial mar- ket frictions, a second-order approximation of social welfare includes a term involv- ing credit, in addition to terms for inflation and consumption. As a consequence, the optimal monetary and macroprudential policies must contribute to both finan- cial and price stability. This result holds for various approximated welfares that can change corresponding to macroprudential policy variables. The key features of opti- mal policies are as follows. The optimal monetary policy requires keeping the credit market countercyclical against the real economy. Commitment in monetary and macro- prudential policy, rather than approximated welfare, justifies history dependence and pre-emptiveness. Appropriate combinations of macroprudential and monetary policy achieve perfect financial and price stability.