Reserve Bank of New Zealand
Wellington, September 11, 2017
A new discussion paper ‘Macroprudential policies in a low interest-rate environment,’by Fang Yao and Margarita Rubio has been published on the Reserve Bank’s website.
In the aftermath of the global financial crisis, a new set of challenges has emerged for macroeconomic policy makers. One of the major changes in the post-crisis environment is a significant and permanent decline in interest rates. In many economies, the short-term nominal interest rate has been close to zero. Monetary policymakers have encountered difficulties in stimulating the economy because the interest rate cannot be lowered any further. Moreover, when interest rates are persistently low, agents tend to engage in speculative investment in assets, such as real estate. Therefore, low interest rates may also contribute to asset price bubbles and excessive leverage, which pose risks to financial stability.
One of the policies that has become important after the crisis is the so-called macroprudential policy, aimed at ensuring a more stable financial system. In this paper, we focus on the use of macroprudential policies in an economic environment in which interest rates are low. We argue that, in a low interest-rate environment, the case for using macroprudential policies becomes even stronger. On the one hand, greater financial volatility due to low interest rates calls for macroprudential policies to contain excessive bank lending. On the other hand, macroprudential policy may also complement monetary policy when the interest rate is close to zero and cannot be used to stabilise the economy anymore.
We build an economic model for policy evaluation that can take into account that nominal interest rates are subject to a zero lower bound and cannot become negative. We calibrate the model to characteristics of the US economy where the Federal funds rate has been close to zero for 7 years. Within this setting, we find that when the interest rate is persistently low, activity in the financial markets and the wider economy, becomes more volatile. Therefore, we propose macroprudential policy as a candidate to stabilise the economy in this context. On the one hand, we find that in a low interest-rate environment, tighter macroprudential policies can stabilise financial markets. We also find, on the other hand, that macroprudential policies could help monetary policy stimulate the economy when interest rates are close to zero.