Monetary and Banking Research Institute
Date:8/29/2018 4:06:16 PM   |   Code : 293836
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The frequent occurrence of financial crises over the past three decades highlights the adverse effects of financial sector’s fluctuations on the real sector. They have also revealed the inadequacy of the conventional regulatory framework and financial supervision to ensure the stability of the financial system as a whole. In response to these shortcomings and maintaining financial stability, macro-prudential policy has been recently focused by policymakers, especially central banks. Therefore, the structure of Iran’s monetary policy and its relationship with macro-prudential policy to achieve financial stability is examined.

The review of theoretical foundations and empirical studies suggests that the existence of systematic risks calls for the adoption of macroeconomic tools to control these risks and preserve financial stability. Given that these risks are growing in both time-series and cross-sectional dimensions, macroprudential measures are applied in both dimensions and also on both groups of credit suppliers and applicants. In time dimension, the purpose of these tools is to reduce the pro-cyclical behavior of the financial sector, while in cross-sectional dimension it is to monitor and control the balance sheet interconnectedness of systematically important institutions. By creating buffers to deal with systemic risks, these tools increase the flexibility and resilience of the financial sector against various shocks. Evidence and experiments on the application of macroprudential instruments show that the ratio of credit-to-GDP is one of the useful indicators and contains important information on financial stability. Various studies also suggest that if the macroprudential policy framework aligns with the monetary policies, not only have the greater effectiveness of macroeconomic policies in achieving financial stability, but also improve the performance of the real sector and increase social welfare.

In order to investigate the effectiveness of monetary policy in pursuit of financial stability, as well as evaluating the effects of the application of macroeconomic tools, a structural general equilibrium model based on dynamic stochastic optimization models has been designed and estimated. The results of various simulations suggest that, in current structures, pursuing financial stability as the function of the Central Bank’s monetary rule would reduce the volatility of GDP and the variables of the financial sector. Nevertheless, due to diminution of focus on inflation priority, the fluctuations of inflation will increase to some extent. In contrast, the application of macroprudential policies to achieve financial stability reduce the volatility of GDP and inflation, as well as the variables of the financial sector. However, if the institutional structure of macroprudential policy interacts with monetary policy, it will reduce the fluctuations of macroeconomic variables, including inflation and output in addition to reducing the instability of the financial sector.


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