Optimal Monetary and Macroprudential Policies Post-Basel III

This paper studies the interaction between optimal monetary and macroprudential policies in a small open economy calibrated for the Chilean economy that faces a financial risk shock. A DSGE model that introduces a banking regulator is used to evaluate the welfare implications of using a cyclical capital requirement as proposed in Basel III. Also, it studies the interaction between this capital requirement and the policy interest rate amid a financial stress situation. The results of the calibration exercise suggest that monetary policy should not respond to banking credit fluctuations when a financial risk shock hits because doing so increases the macroeconomic stabilization costs. Regarding welfare gains, the introduction of cyclical capital requirements proposed in Basel III generates significant gains relative to the regime set in Basel II. (Audio: Department of Economic Publications)