Macroprudential Policy Coordination with International Capital Flows

We theoretically illustrate how macroprudential policy spillovers through international capital flows can lead to uncoordinated policy choices that are tighter than would occur with coordination. We consider a symmetric two-country macro model in which countries have limited ability to issue state-contingent contracts in international markets. Accordingly, output endogenously depends on the relative share of wealth held by each country. Because markets are incomplete, welfare can be improved by regulating countries’ borrowing positions. Tighter macroprudential policy in country A (limiting leverage or capital inflows) stabilizes country A and endogenously increases the frequency with which A is relatively more wealthy than country B. Thus, tight policy in A provides incentives for B to choose tight policy as well so that B is not poor on average relative to A. We numerically solve for the coordinated and uncoordinated equilibria when countries choose among countercyclical macroprudential policies.