Macroprudential policy coordination in a currency union

Abstract

This paper evaluates, using a game-theoretic approach, the benefits of coordinating macroprudential policy (in the form of reserve requirements) in a two-country model of a currency union with credit market imperfections. Financial stability is first defined in terms of the volatility of the credit-to-output ratio. The gains from coordination are measured by comparing outcomes under a centralized regime, where a common regulator sets the required reserve ratio to minimize union-wide financial volatility, and a decentralized (Nash) regime, where each country regulator sets that ratio to minimize its own policy loss. Experiments show that, under asymmetric real and financial shocks, the gains from coordination are significant at the union level. Moreover, these gains are higher when the common and national regulators have asymmetric preferences with respect to output stability, when financial markets are more integrated, and when the degree of asymmetry in credit markets between members is larger. Implications of the analysis for macroprudential policy coordination in the euro area are also discussed.

Are there financial stability gains from international macroprudential policy coordination?

“…With the development of global financial integration, empirical studies show that the implementation of macroprudential policies has cross-border spillover effects on cross-border credit volatility. Cross-border spillovers of macroprudential policies affect a country's financial stability, leading to interdependence of macroprudential policies and increasing the need for international coordination of macroprudential policies (Agénor, Jackson, & Jia, 2021).…”