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Macroprudential Policies and Credit Creation

We study the effects of macroprudential policy rules in a small-open economy model in which banks effectively create credit. Banks in the model can generate new finance in the process of extending loans rather than just intermediating funds between savers and borrowers; this has been argued to more accurately capture the dynamics of credit (Jakab and Kumhof 2014). We find that borrower-based macroprudential policies that affect the demand for housing and credit are particularly effective in reducing fluctuations in credit, house prices and defaults, and in improving welfare. They outperform financial institution-based policies that primarily affect the supply of credit.