Optimal Monetary and Macroprudential Policies Post-Basel III

This paper examines the interaction between optimal monetary and macroprudential policies in a small, open economy—calibrated for the Chilean economy—in the face of a financial risk shock. A DSGE model incorporating a banking regulator is used to assess the effect on welfare of implementing a cyclical capital requirement such as that proposed in Basel III, as well as the relationship between this requirement and the monetary policy interest rate in a context of financial stress. The results of this analysis suggest that monetary policy should not respond to fluctuations in bank credit in the face of a financial risk shock, as this would increase the costs of macroeconomic stabilization. With regard to welfare gains, the introduction of the cyclical component of the capital requirement proposed in Basel III generates significant gains compared to the Basel II regime.