Macroprudential Regulation and Financial Stability in Open Economies

  • Pengfei Jia

Student thesis: Phd


In the aftermath of the global financial crisis, researchers and policymakers have shown a renewed interest in the role of capital controls as a macroprudential instrument as well as the international dimensions of macroprudential policies. This thesis discusses macroprudential regulation and financial stability in open economies. Chapter 1 studies the performance of time-varying capital controls on cross-border bank borrowing in an open-economy, dynamic stochastic general equilibrium model with credit market frictions and imperfect capital mobility. The model is parameterized for a middle-income country and is shown to replicate the stylized facts associated with a fall in world interest rates (capital inflows, real appreciation, credit boom, asset price pressures, and output expansion). A capital controls rule, which is fundamentally macroprudential in nature, is defined in terms of either changes in bank foreign borrowing or cyclical output. An optimal, welfare-maximizing rule is established numerically. In addition, the optimal simple rule is shown to perform well relative to the Ramsey policy. The analysis is then extended to solve jointly for optimal countercyclical reserve requirements and capital controls rules. These instruments are complements in the sense that both are needed to maximize welfare. At the same time, a more aggressive credit-based reserve requirement rule also induces less reliance on capital controls. Thus, at the margin, countercyclical reserve requirements and capital controls are partial substitutes in maximizing welfare. Chapter 2 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.
Date of Award31 Dec 2017
Original languageEnglish
Awarding Institution
  • The University of Manchester
SupervisorPierre-Richard Agenor (Supervisor) & Christoph Himmels (Supervisor)

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