The Interplay Between Monetary and Macroprudential Policy

After the 2008 global financial crisis, Central Banks around the world followed expansionary monetary policies and decreased their policy rates to stimulate their economies. However, these measures raised concerns about financial stability of those economies due to the excessive credit growth. In this period, Norway also experienced a boom in the housing market and household indebtedness and financial institution’s exposure to the mortgage credits increased.

Norwegian parliament adopted a legislation on the countercyclical buffer in 2013 to reduce the probability of a crisis and counteract harmful effects in the financial system when a crisis occurs.  Macroprudential tools aim to mitigate possible procyclical effects of banks' lending practices and restrain the build-up of financial imbalances. They also support the monetary authority to reduce output and inflation fluctuations with a smaller adjustment in interest rates.

The Ministry of Finance is responsible for setting the level of the countercyclical buffer based on the recommendations by the Norges Bank. As the technical decision maker, Norges Bank has a key role in defining the relationship between the macroprudential regulation and monetary policy as this interaction shows vital importance in strengthening the financial system resilience.

The Capstone provided a detailed theoretical analysis with empirical findings and then compared different country setups. At the same time, the team analyzed the characteristics of the Norwegian economy and its idiosyncrasies.  Finally the team concluded that monetary and macroprudential policies should interact, but with different objectives assigned to each authority.