International Coordination of Macro-Prudential and Monetary policies 1 Enisse Kharroubi Monetary and Economic Department Bank for International Settlements Annual Bank Conference on Development Economics Multilateralism: Past, Present, and Future. June 17-18, 2019 1 Views expressed here are not necessarily the views of the BIS. Kharroubi () MP and MaP Coordination June 17-18, 2019 1 / 16
Introduction When is international policy coordination desirable? Literature starting from Obsfeld and Rogo¤ (1992) …nds little gains to international coordination on monetary policy (MP). I Negligible welfare losses to domestically oriented monetary policies But what about macro-prudential policy (MaP) ? I Does a similar kind of result hold ? I What drives cooperation gains ? I How the conduct of other policies (MP) a¤ects these gains? Kharroubi () MP and MaP Coordination June 17-18, 2019 2 / 16
An overview of the main results Main results Kharroubi () MP and MaP Coordination June 17-18, 2019 3 / 16
An overview of the main results Main results Does a similar kind of result hold? I Both MaP and MP coordination yields welfare gains. But unlike MP, MaP coordination is a Pareto improvement. I MP takes place ex post, after shock are realized and uncertainty has unraveled, i.e. once countries have become asymmetric I MaP takes place ex ante (risk sharing), under the veil of ignorance and has positive GE spill-overs. Kharroubi () MP and MaP Coordination June 17-18, 2019 3 / 16
An overview of the main results Main results Does a similar kind of result hold? I Both MaP and MP coordination yields welfare gains. But unlike MP, MaP coordination is a Pareto improvement. I MP takes place ex post, after shock are realized and uncertainty has unraveled, i.e. once countries have become asymmetric I MaP takes place ex ante (risk sharing), under the veil of ignorance and has positive GE spill-overs. What drives gains to policy cooperation ? I Frictions to cross-border capital ‡ows Kharroubi () MP and MaP Coordination June 17-18, 2019 3 / 16
An overview of the main results Main results Does a similar kind of result hold? I Both MaP and MP coordination yields welfare gains. But unlike MP, MaP coordination is a Pareto improvement. I MP takes place ex post, after shock are realized and uncertainty has unraveled, i.e. once countries have become asymmetric I MaP takes place ex ante (risk sharing), under the veil of ignorance and has positive GE spill-overs. What drives gains to policy cooperation ? I Frictions to cross-border capital ‡ows How do policies interact with each other ? I Welfare gains to MaP cooperation larger under Nash MP. Kharroubi () MP and MaP Coordination June 17-18, 2019 3 / 16
Introduction Some papers in the literature. Policy coordination: I extensive literature on MP coordination (cross-border, cross-policy). Engel (2016) provides a nice survey. I Much less on MaP coordination. Jeanne (2014), Bengui (2015) and Engel (2015) MP and MaP in open economy: I Objectives: Benigno (2009), Corsetti et. al. (2011), Faia and Monacelli (2008), Bengui (2014), Senay and Sutherland (2018). I E¤ectiveness: Rey (dilemma vs. trilemma), Mendoza (2016) and Aizenmann et al. (2018). I Leakages: Aiyar (2012) for the UK, Barroso et al. (2016) for Brazil Liquidity managment/provision I Under-insurance and pecuniary externalities (Gromb and Vayanos 2002, Lorenzoni 2008 or Stein 2012), particularly in open economy context (Caballero and Krishnamurthy 2003 or Jeanne and Korinek 2010, Brunnermeier and Sannikov (2014)). Kharroubi () MP and MaP Coordination June 17-18, 2019 4 / 16
The model Framework and technologies. A 3-period economy à la Holmstrom-Tirole (1998) with 2 regions and risk neutral banks maximizing …nal pro…ts. Kharroubi () MP and MaP Coordination June 17-18, 2019 5 / 16
The model Framework and technologies. A 3-period economy à la Holmstrom-Tirole (1998) with 2 regions and risk neutral banks maximizing …nal pro…ts. At date 0, banks hold unit endowment and invest in risky assets. I At date 1, risky asset returns 1 in one region and 0 in the other I Regions are symmetric and there is no aggregate uncertainty. Kharroubi () MP and MaP Coordination June 17-18, 2019 5 / 16
The model Framework and technologies. A 3-period economy à la Holmstrom-Tirole (1998) with 2 regions and risk neutral banks maximizing …nal pro…ts. At date 0, banks hold unit endowment and invest in risky assets. I At date 1, risky asset returns 1 in one region and 0 in the other I Regions are symmetric and there is no aggregate uncertainty. At date 1, once uncertainty is resolved: I If risky assets pay-o¤: banks can save for a return r ( < 1 ) I If risky assets do not pay-o¤: banks can reinvest with unit return 1. Kharroubi () MP and MaP Coordination June 17-18, 2019 5 / 16
The model Markets I Ex ante risk sharing : At date 0, banks can issue claims on their risky assets and buy claims on the other region’s risky assets. I Ex post market for liquidity : At date 1, once uncertainty is resolved, banks can exchange liquidity. Kharroubi () MP and MaP Coordination June 17-18, 2019 6 / 16
The model Markets I Ex ante risk sharing : At date 0, banks can issue claims on their risky assets and buy claims on the other region’s risky assets. I Ex post market for liquidity : At date 1, once uncertainty is resolved, banks can exchange liquidity. Policies I Monetary policy sets the return r to savings between date 1 and date 2 ( deposit facility ). I Macro-prudential policy sets the max limit on banks’ borrowing at date 0 ( leverage ratio or CFM ). Kharroubi () MP and MaP Coordination June 17-18, 2019 6 / 16
The decentralized equilibrium The portfolio choice for banks: L ; L � ; D [ 1 + L � L � � R 1 L ] R � 1 L � + D � R 2 D ] 2 + [ β R � max Kharroubi () MP and MaP Coordination June 17-18, 2019 7 / 16
The decentralized equilibrium The portfolio choice for banks: L ; L � ; D [ 1 + L � L � � R 1 L ] R � 1 L � + D � R 2 D ] 2 + [ β R � max s.t. D � 1 � λ and L � m ( 1 + L � L � ) Kharroubi () MP and MaP Coordination June 17-18, 2019 7 / 16
The decentralized equilibrium The portfolio choice for banks: L ; L � ; D [ 1 + L � L � � R 1 L ] R � 1 L � + D � R 2 D ] 2 + [ β R � max s.t. D � 1 � λ and L � m ( 1 + L � L � ) Assuming max ( r ; r � ) � ( R 2 ; R � 2 ) � 1, the equillibrium on market ex post funding: 1 + L � � L 1 L � + D β R � = | {z } | {z } Funding Supply Funding Demand Kharroubi () MP and MaP Coordination June 17-18, 2019 7 / 16
The decentralized equilibrium At the equilibrium, borrowing and issuance constraints bind : L = m ( 1 + L � L � ) D = 1 � λ and D � = 1 � λ � L � = m � ( 1 + L � � L ) Negative spill-over : Higher issuance by one region implies lower issuance by the other region. Kharroubi () MP and MaP Coordination June 17-18, 2019 8 / 16
The decentralized equilibrium At the equilibrium, borrowing and issuance constraints bind : L = m ( 1 + L � L � ) D = 1 � λ and D � = 1 � λ � L � = m � ( 1 + L � � L ) Negative spill-over : Higher issuance by one region implies lower issuance by the other region. At the equilibrium, ex post funding is in excess supply : L � λ + ( 1 � max ( r ; r � )) L � ( R 2 ; R � 2 ) = max ( r ; r � ) and L � � λ � + ( 1 � max ( r ; r � )) L Positive spill-over : Higher issuance by one region allows for larger issuance by the other region. Kharroubi () MP and MaP Coordination June 17-18, 2019 8 / 16
Optimal monetary policy The non-cooperative equilibrium Optimal monetary policy: h � � i 1 � 1 R � max π = 1 + β R 2 L 2 + ( 1 � R 2 ) ( 1 � λ ) r s.t. R 2 = R � 2 = max ( r ; r � ) Kharroubi () MP and MaP Coordination June 17-18, 2019 9 / 16
Optimal monetary policy The non-cooperative equilibrium Optimal monetary policy: h � � i 1 � 1 R � max π = 1 + β R 2 L 2 + ( 1 � R 2 ) ( 1 � λ ) r s.t. R 2 = R � 2 = max ( r ; r � ) Optimal interest rates in Nash equilibrium: � � λ �� L ; λ � r = r � = r n ( L ; L � ) � β 1 + max L � 2 Equilibrium interest rate main properties: I optimal for one region (core), too high for the other (periphery) I decreases in domestic banks leverage. Kharroubi () MP and MaP Coordination June 17-18, 2019 9 / 16
Optimal macro-prudential policy The non-cooperative equilibrium: Core vs. Periphery Macro-prudential policy in the core region: h � � i 1 � 1 max π = λ + β r n ( L ) L r n ( L ) m s.t. L = m ( 1 + L � L � ) and L � λ + ( 1 � r n ( L )) L � No trade-o¤ for MaP : higher m ) higher L ) higher pro…ts π Kharroubi () MP and MaP Coordination June 17-18, 2019 10 / 16
Optimal macro-prudential policy The non-cooperative equilibrium: Core vs. Periphery Macro-prudential policy in the core region: h � � i 1 � 1 max π = λ + β r n ( L ) L r n ( L ) m s.t. L = m ( 1 + L � L � ) and L � λ + ( 1 � r n ( L )) L � No trade-o¤ for MaP : higher m ) higher L ) higher pro…ts π Macro-prudential policy in the periphery region: h � � L � i λ � + π � = 1 � 1 max β r n ( L ) r n ( L ) m � L � = m � ( 1 + L � � L ) and L � � λ � + ( 1 � r n ( L )) L s.t. L = m ( 1 + L � L � ) Trade-o¤ for MaP : higher m � ) higher L � but higher r n ( L ) Kharroubi () MP and MaP Coordination June 17-18, 2019 10 / 16
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