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An Optimal Macroprudential Policy Mix for Segmented Credit Markets

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The contribution of non-bank financing to financial markets is becoming increasingly important. This poses new challenges and risks to financial stability because imbalances can emerge beyond the traditional banking sector. In this context, regulators need to address the role of non-bank financial institutions when designing macroprudential policy. I contribute to the literature on this topic by studying whether simple, implementable macroprudential policy rules can help stabilize economies that have segmented credit markets.

To do this, I build a dynamic stochastic general equilibrium model with a banking sector and a bond sector. Banks supply loans to firms that cannot access bond finance. Mutual funds enable the issuance of corporate bonds of firms with access to capital markets. I consider two alternative macroeconomic policy frameworks: 1) a benchmark Taylor rule for monetary policy and 2) a combination of optimized monetary and macroprudential policy rules. I compare welfare outcomes under these frameworks following aggregate and sector-specific shocks. Consistent with the literature, I consider alternative targets for the macroprudential rule: sector-specific credit volumes, finance premia, or asset prices.

Three main results emerge. First, the optimal mix of macroprudential and monetary policy outperforms a simple Taylor rule in response to aggregate shocks. The optimal macroprudential policy stabilizes bank credit and bond volumes. Such a rule alleviates the tightness of bank capital constraints and that of the bond market at times of financial distress. Second, there is no trade-off between price and financial stability following aggregate shocks. And third, in the presence of sector-specific financial shocks, the policy mix that maximizes welfare in response to aggregate financial shocks yields negligibly smaller welfare gains than the optimal policy mix.