The Journal of Financial Crises Volume 1 Issue 4 2019 Incorporating Macroprudential Financial Regulation into Monetary Policy Aaron Klein The Brookings Institution Follow this and additional works at: https://elischolar.library.yale.edu/journal-of-financial-crises Part of the Administrative Law Commons, Banking and Finance Law Commons, Economic History Commons, Economic Policy Commons, Economic Theory Commons, Finance Commons, International Relations Commons, Macroeconomics Commons, Policy Design, Analysis, and Evaluation Commons, Political Economy Commons, Public Affairs Commons, Public Economics Commons, and the Public Policy Commons Recommended Citation Klein, Aaron (2019) "Incorporating Macroprudential Financial Regulation into Monetary Policy," The Journal of Financial Crises: Vol. 1 : Iss. 4, 1-22. Available at: https://elischolar.library.yale.edu/journal-of-financial-crises/vol1/iss4/1 This Article is brought to you for free and open access by the Journal of Financial Crises and EliScholar – A Digital Platform for Scholarly Publishing at Yale. For more information, please contact
[email protected]. Incorporating Macroprudential Financial Regulation into Monetary Policy+ Aaron Klein Abstract This paper proposes two insights into financial regulation and monetary policy. The first enhances understanding the relationship between them, building on the automobile metaphor that describes monetary policy: when to accelerate or brake for curves miles ahead. Enhancing the metaphor, financial markets are the transmission. In a financial crisis, markets cease to function, equivalent to a transmission shifting into neutral. This explains both monetary policy’s diminished effectiveness in stimulating the economy and why the financial crisis shock to real economic output greatly exceeded central bank forecasts. The second insight is that both excess leverage and fundamental mispricing of asset values are necessary to produce a crisis.