Policy interactions and systemic stability: How monetary conditions influence macroprudential effectiveness?

This study examines how the stance of monetary policy shapes the effectiveness of macroprudential tools in mitigating systemic risk. While prior literature highlights the stabilizing role of macroprudential policy, evidence on its interaction with monetary policy is mixed and often neglects differences across instruments. We address this gap by constructing separate indices for tools targeting bank capital and liquidity versus those aimed at borrowers, using a panel of 37 countries (2011–2021) and employing panel fixed-effects and system-GMM estimations. Our results show that only tools targeting bank capital and liquidity significantly reduce systemic risk, measured via an aggregate country-level banks’ Z-score. Importantly, their effectiveness is substantially weakened under a restrictive monetary stance, revealing a critical policy interaction transmitted through bank profitability. These findings highlight the need to consider the prevailing monetary environment when designing macroprudential interventions.