Summary:
Since the severe global financial crisis in 2008, macro-prudential policies have resurged, while the use of monetary policy to prevent financial imbalances and systemic risks has been widely criticized. As a result, a series of macro-prudential policies have been introduced in many countries. China uses a two-pillar adjustment framework involving both monetary and macro-prudential policy. In October 2017, the report of the 19th National Congress of the Communist Party of China identified the need to “improve the framework of regulation underpinned by monetary policy and macro-prudential policy… to forestall systemic financial risks.” The two-pillar adjustment framework is expected to maintain financial stability. However, how well do monetary policy and macro-prudential policy cooperate under the two-pillar adjustment framework to better preserve financial stability？ How can monetary policy and macro-prudential policy cooperate better in different economic environments and with different policy objectives？ While many studies investigate the effect of either monetary policy or macro-prudential policy, few studies focus on the coordination between these two types of policies. Despite several papers investigating these questions theoretically, there is still no consensus and there is a lack of empirical evidence, especially at the micro level. To address this gap, we investigate empirically the micro-stabilization effect of monetary policy and macro-prudential policy under the two-pillar adjustment framework at both the bank level and the firm level. Our empirical results using data on China's banks and firms from 2009 to 2018 show that the monetary policy rate is negatively related to bank risk taking but that macro-prudential policy can weaken the transmission effect of monetary policy's bank risk taking channel and restrict excessive risk taking of banks under easy monetary policy. Firms have an incentive to improve their debt ratio under easy monetary policy, but this effect can be effectively restrained by macro-prudential policy. Macro-prudential policy can reduce firms' dependence on bank loans, forcing firms to optimize their debt structure. The cooperation between monetary policy and macro-prudential policy can strengthen this effect. Compared with monetary policy or macro-prudential policy acting in isolation, the coordination between these two types of policies under the two-pillar adjustment framework has a better stabilizing effect on banks and firms. We further investigate the different effects of the two-pillar adjustment at different points in the business cycle and on different types of banks and firms. The implementation effect of the two-pillar adjustment is related to the business cycle because of the different policy objectives in different economic environments. As a result, the impact of the two-pillar adjustment on banks' risk exposure and firms' debt behavior also differs in boom and bust periods. Moreover, the effect of the two-pillar adjustment framework also differs for banks and firms of different types. These conclusions have an obvious policy implication that attention should be paid to the economic environment and to the heterogeneity of regulatory targets in the processes of policy formulation and implementation to strengthen the effectiveness of the two-pillar adjustment framework. This paper makes three main contributions. First, unlike studies focusing on the effect of monetary policy or macro-prudential policy in isolation, we pay attention to the coordination between these two types of policies under the two-pillar adjustment framework through a well-designed empirical study using data on banks and firms. Our paper provides new thinking on the coordination between monetary policy and macro-prudential policy and enriches the literature on the two-pillar adjustment framework. Second, we both investigate the micro-stabilization effect of the two-pillar adjustment framework at the bank and firm levels and discuss differences in the micro-stabilization effect by looking at changes over the business cycle and allowing for heterogeneity in banks and firms. Our findings provide complementary evidence of the effectiveness of the two-pillar adjustment framework and shed light on the micro-transmission mechanism of the two-pillar adjustment framework. Finally, our results provide empirical evidence of the validity of China's two-pillar adjustment framework and have policy implications for the improvement of the two-pillar adjustment framework.
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