Macroprudential Policy:Theoretical Rationale,Effectiveness And Application In Capital Flow Management

After the global financial crisis of 2008,policy makers in major economies around the world generally realized that the financial system was more than the simple aggregate of financial institutions.While microprudential regulation only focuses on the risks faced by individual financial institutions,the financial stability at the macroprudential level or systemic level can not be ignored.In this context,regulators in various countries have established macroprudential policy framework to deal with the procyclical and cross-sectional risks raised from the financial system.China has also carried out several beneficial operations in macroprudential policies.For the development of macroprudential policies in recent years,this thesis attempts to solve the following questions: First,what are the fundamental rationales behind macroprudential policies? Second,how effective are macroprudential policies used by countries? Third,does capital flows raise domestic systemic risks? What is role of macroprudential policy in capital flow management? This thesis builds a theoretical model based on externality theory to discuss the motivation of macroprudential policy,and then evaluates the effectiveness of macroprudential policy and the systemic risks associated with capital flows by empirical analysis.On top of that,the thesis analyzes the role of macroprudential policies in capital flow management,the following contents are included:In the first place,this thesis develops a theoretical model to analyze the financing decisions of banks and financial amplification effects,and analyzes the role of ex-ante macroprudential policy in dealing with systemic risks in comparison with the ex-post relief policy.On the fundamental rationales behind macroprudential policy,literatures generally start from the externalities associated with activities of financial intermediaries and markets.Following the existed studies,the thesis develops a three period model and finds that the negative externality arises from banking sector's fire-sales during the financial crisis may cause financial amplification effect.As rational atomistic agents do not generally internalize this pecuniary externality,they would value liquidity less than the social optimum in the state of crisis.In equilibrium the price and quantity of state-contingent bonds issued by banking sector are mainly determined by the valuation of liquidity,which is the marginal contribution of liquidity to banking sector lifetime utility.Therefore,the result of externality is that the banking sector takes too much systemic risks,that is,atomistic agents would pay less debt than social optimum in good times and repay more in financial crisis states.Both ex-post and ex-ante policies can be used to dealing with systemic financial risks.Traditional ex-post interventions include liquidity assistance and asset purchase,which can alleviate the amplification effect during the financial crisis.However,the expectation of ex-post policies may create moral hazard and lead to excessive risk-taking of the banking sector,weakening the policy's effect.Debt limit requirement and Pigovian tax are ex-ante macroprudential policies.These policy tools can induce decentralized agents to internalize the pecuniary externalities that may arise in the future when making financing decisions,so as to achieve the objective of containing systemic risk,and would not create moral hazard of banking sector.Although ex-post policies are important in financial crisis management,macroprudential policy can play a complementary role.Policy makers are recommended to strengthen the application of macroprudential policies in curbing the accumulation of systemic risk,and focuses on the correction of externality in practice.In addition,the thesis reviews the use of macroprudential instruments around the world,investigates the effects of macroprudential policies using a dynamic panel data model,and analyzes the factors that may affect the effectiveness of macroprudential policies from the perspective of financial sector heterogeneity.We construct a macroprudential index for seven categories of macroprudential tools(countercyclical capital requirements,dynamic provisioning requirements,consumer loan limits,credit growth limits,LTV caps,DTI caps and other macroprudential tools related to housing),and provides an empirical analysis based on the quarterly data of 29 sample economies covering the period from 2000 to 2013.According to the macroprudential data of sample economies,the macroprudential tools used in advanced economies mainly target the housing market,while in emerging economies,macroprudential tools are no longer limited to the housing market,bank credit has also been an important concern.Macroprudential policies have been used far more actively since the global financial crisis of 2008 compared with the pre-crisis period.The event study discusses the experience of Turkey and Canada in macroprudential policy use.In the section of empirical study,the thesis analyzes the impact of macroprudential policies on credit growth and house prices,and the estimation results support the effectiveness of macroprudential policies.Both bank-related and housing-related macroprudential measures have played important roles in containing credit growth,while dynamic provisioning requirements,consumer loan limits,LTV caps,DTI caps and other housing-related macroprudential tools have significant effects.For house prices,we find that only housing-related macroprudential measures can significantly lower house price appreciation,and LTV caps,DTI caps and other housing-related macroprudential tools are most effective.We also conduct some robustness chencks,the results remain the same regardless of estimation method.In extensions,the thesis analyzes the heterogeneity factors of financial sector that may affect the effectiveness of macroprudential policy.Empirical evidences also show that the effectiveness of macroprudential policy is weakened in economies with high degrees of banking openness,banking concentration and low degrees of banking competition,indicating the possibility of circumvention of policies.And economies with high bank Z-scores response more strongly to macroprudential policies.The policy implication is that the effect of macroprudential policy operation is remarkable,which plays an important complementary role for monetary policy.A well designed macroprudential policy framework can improve the effectiveness of tools and reduce the cost of policy circumvention.The impact of capital flows and financial sector heterogeneity should be accounted in policy-making.Finanlly,we develop a model to analyze the procyclicality of capital flows,investigate the impact on systemic risk of capital flows based on empirical regression,and discuss the application of macroprudential policy in capital flow management.The thesis set up a model to analyze the the impact of the optimum behavior of domestic household and firm sectors on capital flows.The results show that there exist a positive correlation between capital inflows and domestic business cycle.When productivity raises,domestic firms expand investment and make more profits,domestic households obtain more income which would drive up asset prices and cross-border borrowing.Therefore,capital inflows faced by domestic firms and households increase.On the other hand,the decline of productivity leads to the contraction of investment,the reduction of firm profit and household income,and capital inflows decrease in response.Housing mortgage loan mechanism can also have amplification effect on the procyclical capital flows.Furthermore,the model also analyzes the impacts of capital flows on systemic risks in the scenario of international interest rate change.In the empirical study,the thesis compiles a panel dataset of 53 sample economies from 2000q1 to 2018q4 to examine the association between net capital inflows and credit growth as well as house price growth.The panel regression results indicate that capital inflows have significant effct in elevating systemic risk.For advanced economies,capital inflows mainly affect household credit,and the impact of capital flow composition is little.Capital inflows in emerging market economies have a significant role in boosting the credit growth of both households and firms,and the compositions of capital inflow have different effect.In the part of extension,we analyze the factors that may affect the association between capital inflows and systemic risk,and find that capital inflows have less effect in increasing credit growth and house price growth in economies with higher financial development and less procyclical capital flows.For emerging market economies,flexible exchange rate regime and capital control could limit the accumulation of procyclicality raised by capital flows.On this basis,the thesis discusses the role of macroprudential policy in coping with capital flows in comparation with capital flow management measures.In managing capital inflow,macroprudential tools can address the accumulation of procyclicality effectively.But during the period of capital outflow,the effectness of macroprudential policy still needs further study.Panel regression results support the effectiveness of macroprudential policies in limiting cyclical capital flows.The case study of China indicates that macroprudential tools can contain the accumulation of procyclicality raised by capital flows.To dealing with the systemic risks associated with capital flows,policy makers in emerging market economies are recommended to promote the development of domestic financial systems,and enrich capital flow management toolkit by improve macroprudential policies.