Monetary and Macroprudential Policies in a Leveraged Economy

Abstract: We examine the optimal monetary policy in the presence of endogenous feedback loops between asset prices and economic activity when macroprudential policies can also be pursued. Absent macroprudential policies, the optimal monetary policy leans against asset prices and can be closely approximated, using a speed-limit rule that responds to the growth of financial variables. An endogenous feedback loop is crucial for this result: price stability is otherwise quasi-optimal. Similarly, a simple macroprudential rule that links reserve requirements to credit growth dampens the endogenous feedback loop and leads to near price stability. State-contingent taxes on lending are shown to be welfare-improving.