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Disinflation costs and macroprudential policies: real and welfare effects

Disinflation costs and macroprudential policies: real and welfare effects This paper analyzes real and welfare effects of a permanent change in inflation rate, focusing on macroprudential policy’ role and its interaction with monetary policy.Design/methodology/approachWhile investigating disinflation costs, the authors simulate a medium-scale dynamic general equilibrium model with borrowing constraints, credit frictions and macroprudential authority.FindingsProviding discussions on different policy scenarios in a context where still it is expected high inflation, there are three key contributions. First, when macroprudential authority actively operates to improve financial stability, losses caused by disinflation are limited. Second, a Taylor rule directly responding to financial variables might entail a trade-off between price and financial stability objectives, by increasing disinflation costs. Third, disinflation is welfare improving for savers, while costly for borrowers and banks. Indeed, while savers benefit from policies reducing price stickiness distortion, borrowers are worried about credit frictions, coming from collateral constraint.Practical implicationsThe paper suggests threefold policy implications: the macroprudential authority should actively intervene during a disinflation process to minimize costs and financial instability deriving from it; policymakers should implement a disinflationary policy stabilizing also output; the central bank and the macroprudential regulator should pursue financial and price stability goals, separately.Originality/valueThis paper is the first attempt to study effects of a permanent inflation target reduction in focusing on the macroprudential policy’ role. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Economic Studies Emerald Publishing

Disinflation costs and macroprudential policies: real and welfare effects

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References (35)

Publisher
Emerald Publishing
Copyright
© Emerald Publishing Limited
ISSN
0144-3585
DOI
10.1108/jes-03-2023-0161
Publisher site
See Article on Publisher Site

Abstract

This paper analyzes real and welfare effects of a permanent change in inflation rate, focusing on macroprudential policy’ role and its interaction with monetary policy.Design/methodology/approachWhile investigating disinflation costs, the authors simulate a medium-scale dynamic general equilibrium model with borrowing constraints, credit frictions and macroprudential authority.FindingsProviding discussions on different policy scenarios in a context where still it is expected high inflation, there are three key contributions. First, when macroprudential authority actively operates to improve financial stability, losses caused by disinflation are limited. Second, a Taylor rule directly responding to financial variables might entail a trade-off between price and financial stability objectives, by increasing disinflation costs. Third, disinflation is welfare improving for savers, while costly for borrowers and banks. Indeed, while savers benefit from policies reducing price stickiness distortion, borrowers are worried about credit frictions, coming from collateral constraint.Practical implicationsThe paper suggests threefold policy implications: the macroprudential authority should actively intervene during a disinflation process to minimize costs and financial instability deriving from it; policymakers should implement a disinflationary policy stabilizing also output; the central bank and the macroprudential regulator should pursue financial and price stability goals, separately.Originality/valueThis paper is the first attempt to study effects of a permanent inflation target reduction in focusing on the macroprudential policy’ role.

Journal

Journal of Economic Studies – Emerald Publishing

Published: Aug 13, 2024

Keywords: Disinflation; Macroprudential policy; Loan-to-value ratio; Monetary policy; Sacrifice ratio; Welfare effects; D6; E31; E44; E52; E58; G28

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