Optimal Macroprudential and Fiscal Policy in a Monetary Union

Abstract

The growing concern about the financial system stability has turned macroprudential policy into a key instrument of the policy mix. Through a two-country model for a monetary union, I evaluate the optimal combinations of macroprudential and fiscal policy, both in terms of welfare maximization and loss function minimization (stability). I find that the advisability to coordinate macroprudential and fiscal policy depends on the kind of shock that drives the business cycle fluctuations. In the event of financial shocks, macroprudential-fiscal coordination at the national level entails the highest welfare improvements. Under supply shocks, the best option regarding welfare, is the scenario where macroprudential and fiscal policies coordinate to stabilize union aggregate variables. And, in the case of a preference shock, the macroprudential-fiscal non-coordination scenario achieves the largest increases in welfare.