Impairment of monetary policy independence by global financial cycles and the mitigating role of macroprudential policies

Abstract

ABSTRACT In this paper, we study the impairment in monetary policy caused by different forms of global financial cycles. We find that while both equity inflows and outflows cycles do exert influence over monetary policy, the bond inflows cycle does not have a significant impact. Further, we discuss the role of macroprudential policies in mitigating this impairment by using Difference-in-Difference with heterogeneous treatment effects which is robust to presence of heterogeneity across both time periods and groups. We find that FX-based policies such as Capital Restrictions on Foreign Exchange positions and Limits on Foreign Exposure alongside SIFIs and Loan Loss Provisioning are effective in reducing the impairment.