The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
We study interactions between monetary and macroprudential policies in a model with nominal and financial frictions. The latter derive from a financial sector that provides credit and liquidity services that lead to a financial accelerator-cum-fire-sales amplification mechanism. In response to fluctuations in world interest rates, inflation targeting dominates standard Taylor rules, but leads to increased volatility in credit and asset prices. The use of a countercyclical macroprudential instrument in addition to the policy rate improves welfare and has important implications for the conduct of monetary policy. 'Leaning against the wind' or augmenting a standard Taylor rule with an argument on credit growth may not be an effective policy response.