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Financial Openness, Bank Capital Flows, and the Effectiveness of Macroprudential Policies

Hao Jin () and Chen Xiong ()

No 2018-007, CAEPR Working Papers from Center for Applied Economics and Policy Research, Department of Economics, Indiana University Bloomington

Abstract: We study the effectiveness of macroprudential policies in mitigating credit growth in open economies. Empirically we find that macroprudential policies contain domestic credit growth but are less effective in financially more integrated economies due to greater cross-border bank borrowing. We develop a small open economy DSGE model with cross-border bank financing to interpret the empirical findings and quantitatively evaluate the macroeconomic and welfare implications of macroprudential policies. Consistent with the empirical evidence, our model shows that banks contract credits and increase the fraction of foreign financing in response to macroprudential policy tightening. This liability composition shift significantly under-mines the stabilizing effect and welfare gains of macroprudential policies, so they become less effective in financially more open economies. Our results also suggest it is desirable to implement more restrictive macroprudential regulations when capital moves more freely.

Keywords: Intermediary; Financial Frictions; Financial Openness; Macroprudential Policy (search for similar items in EconPapers)
JEL-codes: E32 E44 F38 F41 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2018-08
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-opm
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Related works:
Working Paper: Financial Openness, Bank Capital Flows, and the Effectiveness of Macroprudential Policies (2019)
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