Macroprudential Policy Interlinkages

Abstract

The IMF recently updated its institutional view on capital flow management and macroprudential policies for emerging markets (EMs). The framework advocates a variety of prudential tools to deal with generally complex and heterogeneous financial flows. This paper provides a normative justification for this integrated approach when investors have access to multiple assets. As is well-known, the EM overborrows in international markets, which justifies to actively manage international capital flows. However, as a novel result, this paper also advocates complementary domestic macroprudential policies: reallocating domestic resources toward internationally constrained borrowers improves welfare because it shifts funds to households with a higher marginal propensity to consume. This result emerges independent of any domestic externality. A numerical exercise further shows that partial regulation can increase the severity of a recession relative to no regulation.