Summary:
The report of the 19th National Congress of the Communist Party of China (CPC) calls for improving the regulatory framework underpinned by both monetary policy and macro-prudential policy (hereinafter referred to as the “two-pillar” policy framework, ensuring that no systemic risks occur, and maintaining the overall stability of the economy and financial system. In theory, the traditional monetary policy framework is apt for total volume control. Although it plays a fundamental role in maintaining economic and financial stability, the policy framework anchored by CPI cannot effectively prevent financial imbalances and systemic risks in specific areas. At the same time, macro-prudential policies can make targeted adjustments based on the monetary policy, and can thus better achieve the objectives of financial stability and the prevention of systemic risks. Although the research on macro-prudential policies is abundant and has been enriched constantly, there are still some controversies on whether the inclusion of macro-prudential policies is conducive to resisting economic and financial shocks and the role of counter-cyclical adjustment tools in macro-prudential policies, which call for further research. In particular, there are few studies on how to form a reasonable and effective coordination between monetary policy and macro-prudential policy under the “two-pillar” framework. In light of the practical situation of China's economy, this paper tries to construct a DSGE model with four departments based on the Tayler & Zilberman (2016) model. This paper complements and extends the existing literature in the following three basic aspects. First, this paper introduces collateral constraint and several key financial variables, such as the probability of default, non-performing loan ratio and the probability of collateral recovery to the traditional DSGE framework, and identifies the specific impacts of different financial shocks and the endogenous transmission mechanism between finance and entity economy. Second, the paper introduces the central bank and describes a policy portfolio that includes both monetary policy rules and macro-prudential policy rules, and provides basic modeling design for the analysis of the “two-pillar” regulatory system. Third, based on the improved model framework, this paper examines a number of alternative pegging variables for the macro-prudential policy, and comprehensively analyzes whether and how the macroprudential policy can help to achieve the goal of financial stability and economic stability when facing different economic or financial shocks. The purpose of this study is to investigate the effect of the coordination of monetary policy and macro-prudential policy on economic and financial stability, especially in the face of economic and financial shocks. Bringing the “two-pillar” policy framework and the financial department into a DSGE model, this study reached three basic conclusions. First, the coordination of monetary policy and macro-prudential policy exerts a better effect on stabilizing the economic and financial system than pure monetary policy tools. Second, the “two-pillar” policy framework is especially effective in stabilizing the economic and financial system when facing with financial shocks. This result implies that macro-prudential policy plays a complementary role to monetary policy by stabilizing financial system, whereas monetary policy focuses on stabilizing the entity economic system (output and inflation). Third, the “two-pillar” policy framework helps improve the stability of the economic and financial system regardless of whether the monetary policy tool is price-based or quantitative. As a result, the effectiveness of the “two-pillar” policy framework does not vary with different monetary policies, which provide an evidence that the “two-pillar” policy framework has general applicability.
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