Abstract
How does monetary policy impact upon macroprudential regulation? This paper models monetary policy's transmission to bank risk taking, and its interaction with a regulator's optimization problem. The regulator uses its macroprudential tool, a leverage ratio, to maintain financial stability, while taking account of the impact on credit provision. A change in the monetary policy rate tilts the regulator's entire trade-off. We show that the regulator allows interest rate changes to partly pass through to bank soundness by not neutralizing the risk-taking channel of monetary policy. Thus, monetary policy affects financial stability, even in the presence of macroprudential regulation.
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