Macroprudential Policy Interlinkages

Abstract

The IMF recently updated its institutional view on capital flow management and
macroprudential policies for emerging markets. 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 emerging market 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: A reallocation of domestic resources towards 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.

Keywords: Macroprudential Policies; Capital Controls; Emerging Markets; Welfare

JEL Classification: F34, F41, E44, D62