Optimal monetary and macroprudential policy in a currency union

The financial crisis proved strikingly that financial frictions play a crucial role for system risk and policymakers have overlooked financial stability. The obvious candidate for addressing financial stability is macroprudential policy. In this paper we study the optimal (Ramsey) monetary and macroprudential policy mix in a currency union in the case of different kinds of aggregate and idiosyncratic shocks. The monetary and macroprudential instruments are modeled as independent tools. With a union-wide macroprudential tool, full stabilization on the aggregate level is possible, but welfare losses due to fluctuations in relative variables prevail. With country-specific macroprudential tools, full stabilization of shocks is always possible but, as a rule, not optimal. Evaluating the performance of different policy regimes shows that the additional welfare gains from having country-specific macroprudential tools are small and vanish as the ability of the central bank to commit decreases. (C) 2019 Elsevier Ltd. All rights reserved.