Should core countries financial regulators internalize the cross-border spillovers of their macroprudential policy in the euro area?

Financial flows between heterogeneous member states of the euro area were crucial drivers of the imbalances that culminated in the Euro crisis. Macroprudential instruments, by affecting the behavior of international banks, can have secondary effects on the financial cycles of other member states. However, countercyclical tools like the Basel III capital buffer are mostly set by independent authorities with national stabilization mandates. Should regulators coordinate macroprudential policy, and if so how? Using a small two-country NK model with financial frictions, we show that macroprudential responses in core economies can have destabilizing spillover effects on a financially dependent periphery through interbank lending. We subsequently evaluate a policy rule in which the core regulator internalizes these spillovers and we compare it to prevailing national stabilization rule. While national rules deliver a good performance in general, under certain conditions internalization becomes preferable.

Author: Cristina ;Marcos; Jean-Marc , Badarau ;Carias-Flores; Figuet
Volume: 2020 3 (1)
Publisher: INFER
Year: 2020
No. of pages: 4
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