Unpleasant Monetarist Arithmetic: Macroprudential Edition

Abstract

The 2008 crisis highlighted the linkages between the financial sector and the real economy, as well as between the corresponding stabilization policies: macroprudential and monetary (MM arguably the case of Sweden, Norway and other countries post-2010. To allow for richer strategic interactions, we postulate the concept of Stochastic leadership, which generalizes Stackelberg leadership and simultaneous move game by allowing for Calvo-type probabilistic revisions of policy actions. We show that the most likely outcomes are Policy Deadlock, Regime Switching and Macroprudential Dominance, but all three are socially undesirable. This is not only because of excessive financial and economic cycles, but also because monetary policy coerced into leaning against the wind loses full control over price inflation. The separation setup of M&Ms is thus subject to a macroprudential version of unpleasant monetarist arithmetic.