We analyze the effects of macroprudential and monetary policies and their interactions using an estimated dynamic stochastic general equilibrium (DSGE) model tailored to Sweden. Households face a ceiling on their loan-to-value ratio and must amortize their mortgages. The government grants mortgage interest payment deductions. Lending rates are affected by mortgage risk weights. We find that demand-side macroprudential measures are more effective in curbing household debt ratios than monetary policy, and they are less costly in terms of foregone consumption. A tighter macroprudential stance is also found to be welfare improving, by promoting lower consumption volatility in response to shocks, especially when using a combination of macroprudential instruments.

In the aftermath of the Global Financial Crisis a consensus is emerging around a paradigm that tasks financial stability to macroprudential policies, with a role for monetary policy reserved for extraordinary times (IMF., 2015). Monetary policy remains assigned to macroeconomic stability, often via an inflation targeting framework. Current thinking is that macroprudential tools, if deployed in a timely manner, can effectively contain most vulnerabilities, although their effects, especially on welfare, need further study (Claessens, 2014). Yet, as macroprudential policies are still unproven, risks to financial stability cannot be completely excluded from the considerations behind monetary policy decisions (Bernanke, 2015). Indeed, it is possible that, threats to financial stability arise that cannot be adequately addressed by macroprudential instruments, but given their macroeconomic impact, any “leaning against the wind” by monetary policy against such threats can only be justified after a thorough cost-benefit analysis (Svensson, 2016). Coordination between macroprudential instruments and monetary policy, which may support their effectiveness in periods of stress, also needs further analysis (Angelini et al., 2014).