Monetary Policy and Cyclical Systemic Risk - Friends or Foes?

Abstract

We explore the procyclicality of monetary policy decisions towards the financial cycle in the 1995-2015 period on a sample of seven central banks. Using the real interest rate gap and the credit-to-GDP gap, we provide evidence that monetary policy procyclicality is a material issue occurring in more than 50% of observations in expansionary phase of financial cycle. It indicates that the central bank faces conflicting objectives of price and financial stability (as proxied by cyclical systemic risk). Nevertheless, taking into consideration all financial cycle phases, complementariness between price and financial stability is more frequent than cases with conflicting objectives in the UK, Euro Area and the US. The occurrence of potential procyclical behaviour of monetary policy (especially in the financial cycle expansion phases) underlines the need for proactive macroprudential policy.