International coordination of macroprudential policies with capital flows and financial asymmetries

Abstract

Lack of coordination for prudential regulation hurts developing economies but benefits advanced economies. We consider a two-country macro model in which countries have limited ability to issue state-contingent contracts in international markets. Both countries have incentives to stabilize their economy by using prudential limits, but the emerging economy depends on the advanced economy to bear global risk. Intermediating global risk requires bearing systemic risk, which financially developed economies are unwilling to bear, preferring financial stability over credit flows. Advanced economies prefer tighter prudential limits than would occur with coordination, to the harm of emerging economies.

Global banking, financial spillovers and macroprudential policy coordination

“…Among the few contributions available, based explicitly on a game‐theoretic approach, are Agénor et al . (2021) and Chen and Phelan (2021). Agénor et al .…”

“…Yet even though much can be learned from the early literature on international monetary policy coordination-reviewed by Frankel (2016), for instance-research on this issue remains very limited. Among the few contributions available, based explicitly on a game-theoretic approach, are Agénor et al (2021) and Chen and Phelan (2021). Agénor et al (2021) study the effects of coordinated and independent macroprudential policies in a model with financial frictions, as in Gertler and Karadi (2011), and where global banks in a core region lend domestically and to banks in the periphery.…”

“…4 Their results show that the global welfare gain from coordination can be relatively large (of the order of 1-2% of steady-state consumption), essentially because it mitigates significantly the cross-border spillovers of country-specific shocks. Chen and Phelan (2021), dwelling on the continuous-time framework developed by Brunnermeier and Sannikov (2015), formulate a symmetric two-country model in which countries have limited ability to issue state-contingent contracts in international markets. As a result, the relative share of global wealth held by each country affects its own level of output.…”