Consequently the two instruments are imperfect substitutes in terms of their effects on the economy. We shall illustrate this by comparing the impact on the economy of a variety of shocks when only monetary policy is available with the outcomes when the macro-prudential instrument is also available. In each case, policy is set optimally. We assume a quadratic social loss function, which penalises the variance of inflation, output and the physical capital stock about their efficient frictionless levels. Other than the appearance of physical capital, this objective function is standard. Edge (2003) shows that such a term appears when capital accumulation is incorporated into the sticky-price New Keynesian framework and the objective function is derived from first principles (along with a number of other terms, which for simplicity are omitted here), though, with all investment funded through the banking system, we interpret it as capturing financial stability concerns more broadly. We assume a weight of unity on the variance of inflation and weights of 0.01 on the variances of output gap and the capital gap; that is broadly consistent with extant calibrated models in which the objective function is derived from first principles. Since expectations of future inflation, rates of profit, etc., matter in the model, it is valuable for policymakers to be able to commit to future actions so as to influence those expectations, just as in the canonical New Keynesian framework. In the first set of simulations, we assume a single policy maker who can commit (this simplifies solving the model).
Denis Beau: Building an appropriate climate stress testing framework for capital markets Opening remarks by Mr Denis Beau, First Deputy Governor of the Bank of France, at the Future Europe Sustainable Europe Global Virtual Conference "Europe’s global response - promoting global financial coordination towards our common sustainable future", 6 July 2021. * * * I would like to thank you very much for your kind invitation to present the work the Banque de France and the ACPR, its supervisory arm, conducted on climate stress-testing and to share some of the lessons we have drawn from it. I will focus my remarks on 1/ the objectives to be set to such exercice 2/ the tools to be used. ***** 1- I think it is not a matter of debate between financial institutions and their supervisors that climate change affect financial institutions through the traditional risks categories they face. Sizing the exposure to and impact of climate-related drivers on those traditional risk categories is however difficult, given the specificities of those climate-related risk drivers, which are not necessarily economic in nature, and the multiple layers of uncertainty which affect them. In particular, data on past changes in climate and their financial impact may be a particularly poor guide to future magnitude and dynamic of climate related risks. In addition, financial institutions decision-making horizons are usually too short-term oriented to fully account for the long time horizon of risks associated with climate change, the so-called “tragedy of the horizon".