Discussion Paper

No. 2017-85 | October 13, 2017
The interaction between monetary and macroprudential policy: should central banks ‘lean against the wind’ to foster macro-financial stability?


The extensive harm caused by the financial crisis raises the question of whether policymakers could have done more to prevent the build-up of financial imbalances. This paper aims to contribute to the field of regulatory impact assessment by taking up the revived debate on whether central banks should ‘lean against the wind’ or not. Currently, there is no consensus on whether monetary policy is, in general, able to support the resilience of the financial system or if this task should better be left to the macroprudential approach of financial regulation. The author aims to shed light on this issue by analyzing distinct policy regimes within an agent-based computational macro-model with endogenous money. He finds that policies make use of their comparative advantage leading to superior outcomes concerning their respective intended objectives. In particular, he shows that ‘leaning against the wind’ should only serve as first line of defense in the absence of a prudential regulatory regime and that price stability does not necessarily mean financial stability. Moreover, macroprudential regulation as unburdened policy instrument is able to dampen the build-up of financial imbalances by restricting credit to the unsustainable high-leveraged part of the real economy. In contrast, leaning against the wind seems to have no positive impact on financial stability which strengthens proponents of Tinbergen’s principle arguing that both policies are designed for their specific purpose and that they should be used accordingly.

JEL Classification:

E44, E50, G01, G28, C63


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Cite As

Sebastian Krug (2017). The interaction between monetary and macroprudential policy: should central banks ‘lean against the wind’ to foster macro-financial stability? Economics Discussion Papers, No 2017-85, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2017-85

Comments and Questions

Anonymous - Referee report 1
November 30, 2017 - 08:43

see attached file

Alexey Ponomarenko - comment on the Referee report 1
December 10, 2017 - 10:43

I have some reflections on the referee’s comment 3.

I believe that the key idea of credit creation theory is that the extension of banks’ claims on the non-banking sector (in the form of loans, bonds or other securities) simultaneously creates banks’ liabilities to the non-banking sector (most of ...[more]

... them are likely to be categorized as deposits).

Therefore, banks’ purchase of government bonds, either newly issued or initially held by the non-banking sector, may create money.

In both cases, claims on the government and new deposits (liabilities to the non-banking sector) will appear on the banking system balance sheet. In the former case the new claims on banks will initially appear on the government’s balance sheet (and may be subsequently transferred to the private sector as a result of government spending). In the latter case the deposits will appear on the non-banking private sector’s balance sheet (replacing the claims on the government).

For a detailed discussion of the effect of banks’ purchases of government bonds (as opposed to the purchases by the non-banking sector) see http://www.sciencedirect.com/science/article/pii/S0261560614001132

I thank the author and the referee for an insightful work!

Sebastian Krug - Rely to referee report
January 12, 2018 - 17:39

See the file attached

Anonymous - Referee report 2
December 04, 2017 - 09:34

see attached file

Sebastian Krug - Reply to Referee Report
January 06, 2018 - 12:46

see attached file