Macroprudential policies in a low interest-rate environment 

Aim: To discuss the effect of a low interest-rate environment on business and financial cycles and explain how macroprudential policy can, in these circumstances, contribute to macroeconomic stability.

Outcome: Completion of this module will help advisers:

  • Understand why the low interest-rate environment leads to greater macroeconomic volatility and financial instability;
  • Explain the relationship between macroprudential policy and monetary policy; and
  • Explain why monetary policy becomes less effective in a low interest-rate environment.

Abstract: In the aftermath of the global financial crisis, there has been a significant and permanent decline in interest rates. This low interest-rate environment provides a new set of challenges for macroeconomic policy makers as the use of monetary policy to stimulate the economy is restricted because of the persistently low interest rate. As a result, macroprudential policies, such as loan-to-value ratios, have become more important for ensuring a stable financial system. The authors’ modelling demonstrates that macroprudential policies can act as a complement to monetary policy in an environment where interest rates are permanently low and monetary policy is constrained by the zero lower bound. Loan-to-value ratio (LVR) is used as an example to illustrate this.