In the face of spillovers: Prudential policies in emerging economies

Abstract

We examine whether emerging market prudential policies offset the macro-financial spillover effects of US monetary policy. We find that emerging markets with tighter overall prudential policy face significantly smaller, and less negative, spillovers to total credit from US monetary policy tightening shocks. Loan-to-value ratio limits and reserve requirements appear to be particularly effective prudential tools at mitigating the spillover effects of US monetary policy. Our findings indicate that prudential policies can dampen emerging markets' exposure to US monetary policy and the associated global financial cycle, suggesting they may be a useful tool in the face of international macroeconomic policy trade-offs.

Leaning Against the Global Financial Cycle

“…Recently, the policy debate has shifted the attention towards the use of other instruments to tackle the impact of waves and reversals in capital flows, namely macroprudential policies and capital controls. Neanidis (2015), Bergant, Grigoli, Hansen, and Sandri (2020), and Coman and Lloyd (2022) find that a more stringent level of macro-prudential regulation reduces the sensitivity of GDP growth to global financial shocks in EMEs. Risks, however, may migrate towards the non-banking sector, affecting 3 Rey (2013) claims that flexible exchange rates are insufficient to insulate domestic financial conditions from global ones, and that the traditional policy trilemma becomes simply a dilemma between having an independent monetary policy and an open capital account.…”

Capital flow management and monetary policy to control credit growth

“…The hypothesis underpinning the analysis is that US monetary policy has a spillover effect on the domestic monetary policy of EMEs, which react immediately to these international shifts (Bhattarai et al, 2021; Bussiere et al, 2021; Chen & Filardo, He, et al, 2014; Coman & Lloyd, 2022). Potentially, the central banks in EMEs conduct CFM and monetary policies together, then it is useful to incorporate the proxies of these policies in our baseline estimation and prevent omitted variable bias.…”

Effect of Macroprudential Policies on Sovereign Bond Markets: Evidence from the Asean-4 Countries

“…It has been shown that in financial systems of advanced economies, macroprudential policy significantly reduces systemic risk (Karamysheva and Seregina 2022). In emerging markets, tighter prudential policies weaken the negative spillover from US monetary policy shocks (Coman and Lloyd 2022). In the foreign exchange market, a countercyclical macroprudential policy implementation effectively mitigates fluctuations caused by a US interest rate shock (Ouyang and Guo 2019).…”

“…Macroprudential policy instruments are used to promote financial stability (Hanson et al 2011, Masciandaro and Volpicella 2016, Cerutti et al 2017, Karamysheva and Seregina 2022, Coman and Lloyd 2022. By varying minimum capital requirements and building up bank capital buffers, prudential policies control spillovers between financial institutions and reduce procyclical feedback between asset prices and credit.…”

“…By varying minimum capital requirements and building up bank capital buffers, prudential policies control spillovers between financial institutions and reduce procyclical feedback between asset prices and credit. To date, the literature has focused on the effects of prudential policy on various perspectives, such as systemic risk in the financial system (Claessens et al 2013, Klingelhöfer and Sun 2019, Karamysheva and Seregina 2022; spillover shocks from other countries' monetary policy to emerging market's credit and housing prices (Coman and Lloyd 2022); and fluctuations in the real exchange rates caused by a United States (US) interest rate shock (Ouyang and Guo 2019). However, the effectiveness of macroprudential policy in mitigating sovereign bond market vulnerability has not yet been explored in the existing literature.…”