Working Paper

Macroprudential Policy Interlinkages

Abstract: Emerging markets are concerned about sudden stops in international capital flows, which may lead to severe recessions associated with vicious spirals of currency depreciations and tightening borrowing constraints. A common prescription is to impose macroprudential policies, including prudential capital controls, to limit international borrowing especially in foreign currency. This paper analyzes the supportive role of macroprudential policies geared toward the domestic financial market, suggesting that emerging markets should resort to a wide mix of policies, even when the domestic financial market is frictionless. A simple formula provides further insights: domestic and international macroprudential policies are imperfect complements rather than substitutes, due to distinctive characteristics of foreign and domestic currency bonds. Furthermore, the relative importance of domestic macroprudential regulation increases in the return of domestic bonds.

Keywords: Macroprudential Policies; Capital Controls; Emerging Markets; Welfare;

JEL Classification: F34; F41; E44; D62;

https://doi.org/10.18651/RWP2021-10

Bibliographic Information

Provider: Federal Reserve Bank of Kansas City

Part of Series: Research Working Paper

Publication Date: 2021-09-30

Number: RWP 21-10