Optimal Macroprudential Policy and Bank Capital in Open Economies*

Dudley Cooke () and Tatiana Damjanovic ()

No 2025_04, Department of Economics Working Papers from Durham University, Department of Economics

Abstract: This paper studies macroprudential policy in a small open economy with financial intermediation and nominal rigidity. Fluctuations in bank deposit rates - which depend on the focus of monetary policy - create liability-side volatility, destabilize net interest margins, and reduce output. A macroprudential policy which shifts bank funding away from deposits towards equity enhances domestic risk-sharing and mitigates volatility. Optimal macroprudential policy generates bank capital ratios that differ by up to 5 percentage points depending on whether monetary policy stabilizes domestic prices or the exchange rate. Relative to an unregulated economy, macroprudential policy raises welfare by between 0.4 percent and 0.9 percent of steady-state consumption.

Keywords: Bank Capital; Optimal Macroprudential Policy; Monetary Policy; Risk-Adjusted Steady State (search for similar items in EconPapers)
JEL-codes: E52 F41 G11 G15 (search for similar items in EconPapers)
Date: 2025-11
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