Optimal monetary and macroprudential policies under risk taking environment

Abstract

The purpose of this study is to identify the existence of risk taking behavior in economic agents and optimal monetary and macro prudential policy options in Indonesia. Using the household and firm balance sheet data during the period 2002q1-2013q4, our approach found that risk taking behavior occurs both in households and firms in Indonesia. We develop a model whose economic agents consist of households, firms, banks and central banks by treating the bank credit risk as an endogenous variable. The performance of the model suggests that the monetary shock response drives an increase in credit growth. The same pattern occurs in the shock of increasing asset prices and increasing world GDP. Furthermore, this study model contributes to a deeper understanding of the prudential policy framework. In the even of risk taking, either shock by exogenous asset price or world economy shock, monetary policy alone nor macroprudential alone may not be optimal policy responses.