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Macroprudential Policies and Global Finance  

Stijn Claessens, Aaron Mehrotra, and Ilhyock Shim

Macroprudential policy involves using mainly prudential but sometimes also monetary and fiscal tools to reduce systemic risk and achieve financial stability. It is motivated by externalities associated with the buildup of systemic risk over time due to strategic complementarities, fire sales and credit crunches related to a generalized sell-off of assets, and strong cross-institutional interconnectedness. Macroprudential tools apply to both banks and nonbank financial institutions and to different classes of borrowers to the extent that they come with systemic risks. Both advanced economies (AEs) and emerging market economies (EMEs) have steadily increased their use of macroprudential measures since the mid-1990s. Empirical evidence suggests that tighter macroprudential policy has improved banking system resilience and that tools such as lower caps on loan-to-value or debt service ratios have helped reduce housing credit and price growth. Evidence shows that while tightening macroprudential policy is generally effective, relaxing it is less so. By moderating fluctuations in general bank credit, housing/household credit, or house prices, macroprudential policy tends to reduce the severity and likelihood of future crises as well as the volatility of growth, but recent studies also show that it slows output growth. As financial globalization progresses, macroprudential policy may become less effective due to regulatory arbitrage and cross-border leakages, especially in financially more open AEs and EMEs, also given the limited scope for international coordination and the lack of an internationally agreed-upon macroprudential framework. To deal with the associated externally driven risks, many EMEs use foreign exchange (FX)-related macroprudential tools, e.g., FX liability-based reserve requirements, limits on currency mismatch or FX positions, and FX liquidity requirements. In EMEs, FX intervention can also play a macroprudential role. In contrast, AEs rarely use such instruments but use macroprudential capital buffers more actively than EMEs. Recent evidence suggests both positive and negative international spillover effects of these and other macroprudential policies. These and other findings point to the need to build formal models that have a macro-financial stability framework (MFSF) at their core. The framework incorporates the relevant policy tools, their individual effects, and interactions, and captures the channels of financial risk-taking and their implications for global and domestic financial conditions. Such an MFSF includes monetary policy to ensure macroeconomic stability and assist with financial stability, fiscal policy to guarantee fiscal sustainability and limit cyclical economic fluctuations, and macroprudential policy to complement monetary and fiscal policies by strengthening the resilience of the financial system and limiting the buildup of financial imbalances. Research is underway to develop such models, but considerable scope for further work in this area exists.


Capital Controls: A Survey of the New Literature  

Alessandro Rebucci and Chang Ma

This paper reviews selected post–Global Financial Crisis theoretical and empirical contributions on capital controls and identifies three theoretical motives for the use of capital controls: pecuniary externalities in models of financial crises, aggregate demand externalities in New Keynesian models of the business cycle, and terms of trade manipulation in open-economy models with pricing power. Pecuniary and demand externalities offer the most compelling case for the adoption of capital controls, but macroprudential policy can also address the same distortions. So capital controls generally are not the only instrument that can do the job. If evaluated through the lenses of the new theories, the empirical evidence reviewed suggests that capital controls can have the intended effects, even though the extant literature is inconclusive as to whether the effects documented amount to a net gain or loss in welfare terms. Terms of trade manipulation also provides a clear-cut theoretical case for the use of capital controls, but this motive is less compelling because of the spillover and coordination issues inherent in the use of control on capital flows for this purpose. Perhaps not surprisingly, only a handful of countries have used capital controls in a countercyclical manner, while many adopted macroprudential policies. This suggests that capital control policy might entail additional costs other than increased financing costs, such as signaling the bad quality of future policies, leakages, and spillovers.