Macroprudential Policy and the Irish Crisis

Abstract

The interaction between the banking and property sectors has been the source of considerable volatility in the case of Ireland. The Central Bank of Ireland has recently introduced macroprudential instruments that aim to enhance banks’ balance sheet resilience and mitigate the build-up of system risk. We use a new model of the Irish banking and property sectors to examine how both borrower- and lender-based instruments of macroprudential policy may have been effective in countering the extreme macrofinancial dynamics of the boom-bust period. Our simulation results suggest that, while instruments that work through the intermediary may help insulate banks against liquidity risk and portfolio losses, those that target credit demand are significantly more effective in dampening the Irish financial cycle.