IDEAS home Printed from https://ideas.repec.org/p/pen/papers/16-020.html
   My bibliography  Save this paper

Macroprudential Policy: Promise and Challenges

Author

Listed:
  • Enrique Mendoza

    (Department of Economics, University of Pennsylvania)

Abstract

Macroprudential policy holds the promise of becoming a powerful tool for preventing financial crises. Financial amplification in response to domestic shocks or global spillovers and pecuniary externalities caused by Fisherian collateral constraints provide a sound theoretical foundation for this policy. Quantitative studies show that models with these constraints replicate key stylized facts of financial crises, and that the optimal financial policy of an ideal constrained-efficient social planner reduces sharply the magnitude and frequency of crises. Research also shows, however, that implementing effective macroprudential policy still faces serious hurdles. This paper highlights three of them: (i) complexity, because the optimal policy responds widely and non-linearly to movements in both domestic factors and global spillovers due to regime shifts in global liquidity, news about global fundamentals, and recurrent innovation and regulatory changes in world markets, (ii) lack of credibility, because of time-inconsistency of the optimal policy under commitment, and (iii) coordination failure, because a careful balance with monetary policy is needed to avoid quantitatively large inefficiencies resulting from violations of Tinbergen’s rule or strategic interaction between monetary and financial authorities.

Suggested Citation

  • Enrique Mendoza, 2016. "Macroprudential Policy: Promise and Challenges," PIER Working Paper Archive 16-020, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 24 Oct 2016.
  • Handle: RePEc:pen:papers:16-020
    as

    Download full text from publisher

    File URL: https://economics.sas.upenn.edu/sites/default/files/filevault/SSRN%2016-020.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Javier Bianchi, 2011. "Overborrowing and Systemic Externalities in the Business Cycle," American Economic Review, American Economic Association, vol. 101(7), pages 3400-3426, December.
    2. Javier Bianchi & Chenxin Liu & Enrique G. Mendoza, 2016. "Fundamentals News, Global Liquidity, and Macroprudential Policy," NBER Chapters, in: NBER International Seminar on Macroeconomics 2015, National Bureau of Economic Research, Inc.
    3. Kiyotaki, Nobuhiro & Moore, John, 1997. "Credit Cycles," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 211-248, April.
    4. Enrique G. Mendoza & Marco E. Terrones, 2014. "An Anatomy of Credit Booms and their Demise," Central Banking, Analysis, and Economic Policies Book Series, in: Miguel Fuentes D. & Claudio E. Raddatz & Carmen M. Reinhart (ed.),Capital Mobility and Monetary Policy, edition 1, volume 18, chapter 6, pages 165-204, Central Bank of Chile.
    5. Jeanne, Olivier & Korinek, Anton, 2019. "Managing credit booms and busts: A Pigouvian taxation approach," Journal of Monetary Economics, Elsevier, vol. 107(C), pages 2-17.
    6. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393, Elsevier.
    7. John C. Williams, 2010. "Monetary policy in a low inflation economy with learning," Economic Review, Federal Reserve Bank of San Francisco, pages 1-12.
    8. Benigno, Gianluca & Chen, Huigang & Otrok, Christopher & Rebucci, Alessandro & Young, Eric R., 2013. "Financial crises and macro-prudential policies," Journal of International Economics, Elsevier, vol. 89(2), pages 453-470.
    9. S. Rao Aiyagari & Mark Gertler, 1999. ""Overreaction" of Asset Prices in General Equilibrium," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(1), pages 3-35, January.
    10. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
    11. Lawrence J. Christiano & Roberto Motto & Massimo Rostagno, 2014. "Risk Shocks," American Economic Review, American Economic Association, vol. 104(1), pages 27-65, January.
    12. Durdu, C. Bora & Nunes, Ricardo & Sapriza, Horacio, 2013. "News and sovereign default risk in small open economies," Journal of International Economics, Elsevier, vol. 91(1), pages 1-17.
    13. Forbes, Kristin J. & Warnock, Francis E., 2012. "Capital flow waves: Surges, stops, flight, and retrenchment," Journal of International Economics, Elsevier, vol. 88(2), pages 235-251.
    14. Durdu, Ceyhun Bora & Mendoza, Enrique G. & Terrones, Marco E., 2009. "Precautionary demand for foreign assets in Sudden Stop economies: An assessment of the New Mercantilism," Journal of Development Economics, Elsevier, vol. 89(2), pages 194-209, July.
    15. Enrique G. Mendoza, 2005. "Real Exchange Rate Volatility and the Price of Nontradables in Sudden-Stop-Prone Economies," NBER Working Papers 11691, National Bureau of Economic Research, Inc.
    16. Enrique G. Mendoza & Katherine A. Smith, 2014. "Financial Globalization, Financial Crises, and the External Portfolio Structure of Emerging Markets," Scandinavian Journal of Economics, Wiley Blackwell, vol. 116(1), pages 20-57, January.
    17. Schmitt-Grohé, Stephanie & Uribe, Martín, 2016. "Multiple Equilibria in Open Economy Models with Collateral Constraints: Overborrowing Revisited," CEPR Discussion Papers 11623, C.E.P.R. Discussion Papers.
    18. Mark Gertler & Simon Gilchrist & Fabio M. Natalucci, 2007. "External Constraints on Monetary Policy and the Financial Accelerator," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(2‐3), pages 295-330, March.
    19. Enrique G. Mendoza, 2002. "Credit, Prices, and Crashes: Business Cycles with a Sudden Stop," NBER Chapters, in: Preventing Currency Crises in Emerging Markets, pages 335-392, National Bureau of Economic Research, Inc.
    20. Mendoza, Enrique G. & Quadrini, Vincenzo, 2010. "Financial globalization, financial crises and contagion," Journal of Monetary Economics, Elsevier, vol. 57(1), pages 24-39, January.
    21. repec:fth:starer:98-25 is not listed on IDEAS
    22. repec:fth:starer:9825 is not listed on IDEAS
    23. Juan M. Hernandez & Enrique G. Mendoza, 2017. "Optimal v. simple financial policy rules in a production economy with “liability dollarization," Revista ESPE - Ensayos sobre Política Económica, Banco de la Republica de Colombia, vol. 35(82), pages 25-39, April.
    24. Enrique Mendoza & Bora Durdu & Oliver de Groot, 2016. "Global v. Local Methods in the Quantitative Analysis of Open-Economy Models with Incomplete Markets," 2016 Meeting Papers 595, Society for Economic Dynamics.
    25. Chris Woolston, 2014. "Rice," Nature, Nature, vol. 514(7524), pages 49-49, October.
    26. Hyun Song Shin, 2014. "The Second Phase of Global Liquidity and Its Impact on Emerging Economies," Palgrave Macmillan Books, in: Kyuil Chung & Soyoung Kim & Hail Park & Changho Choi & Hyun Song Shin (ed.), Volatile Capital Flows in Korea, chapter 10, pages 247-257, Palgrave Macmillan.
    27. Jonathan Eaton & Mark Gersovitz, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 48(2), pages 289-309.
    28. Mendoza, Enrique G. & Smith, Katherine A., 2006. "Quantitative implications of a debt-deflation theory of Sudden Stops and asset prices," Journal of International Economics, Elsevier, vol. 70(1), pages 82-114, September.
    29. Fuerst, Timothy S., 1992. "Liquidity, loanable funds, and real activity," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 3-24, February.
    30. Claudio Borio, 2003. "Towards a Macroprudential Framework for Financial Supervision and Regulation?," CESifo Economic Studies, CESifo Group, vol. 49(2), pages 181-215.
    31. Enrique G. Mendoza, 2005. "Real Exchange Rate Volatility and the Price of Nontradable Goods in Economies Prone to Sudden Stops," Economía Journal, The Latin American and Caribbean Economic Association - LACEA, vol. 0(Fall 2005), pages 103-148, August.
    32. Michael Keane & Richard Rogerson, 2015. "Reconciling Micro and Macro Labor Supply Elasticities: A Structural Perspective," Annual Review of Economics, Annual Reviews, vol. 7(1), pages 89-117, August.
    33. Michael Keane & Richard Rogerson, 2015. "Reconciling Micro and Macro Labor Supply Elasticities: A Structural Perspective," Annual Review of Economics, Annual Reviews, vol. 7(1), pages 89-117, 08.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Julio A. Carrillo & Enrique G. Mendoza & Victoria Nuguer & Jessica Roldán-Peña, 2021. "Tight Money-Tight Credit: Coordination Failure in the Conduct of Monetary and Financial Policies," American Economic Journal: Macroeconomics, American Economic Association, vol. 13(3), pages 37-73, July.
    2. Stijn Claessens & M Ayhan Kose, 2018. "Frontiers of macrofinancial linkages," BIS Papers, Bank for International Settlements, number 95.
    3. Mariarosaria Comunale, 2017. "Synchronicity of real and financial cycles and structural characteristics in EU countries," CEIS Research Paper 414, Tor Vergata University, CEIS, revised 25 Sep 2017.
    4. Yusuf Soner Baskaya & Ilhyock Shim & Philip Turner, 2024. "Financial development and the effectiveness of macroprudential and capital flow management measures," BIS Working Papers 1158, Bank for International Settlements.
    5. Ales Marsal & Katrin Rabitsch & Lorant Kaszab, 2023. "Undesired Consequences of Calvo Pricing in a Non-linear World," Working and Discussion Papers WP 1/2023, Research Department, National Bank of Slovakia.
    6. Victoria Nuguer & Jessica Roldan-Pena & Enrique Mendoza & Julio Carrillo, 2016. "When the Central Bank Meets the Financial Authority: Strategic Interactions and Institutional Design," 2016 Meeting Papers 1461, Society for Economic Dynamics.
    7. Klingelhöfer, Jan & Sun, Rongrong, 2019. "Macroprudential policy, central banks and financial stability: Evidence from China," Journal of International Money and Finance, Elsevier, vol. 93(C), pages 19-41.
    8. Chousakos, K. & Gorton, G., 2017. "Bank health post-crisis," Financial Stability Review, Banque de France, issue 21, pages 55-67, April.
    9. Dikau, Simon & Volz, Ulrich, 2021. "Central bank mandates, sustainability objectives and the promotion of green finance," Ecological Economics, Elsevier, vol. 184(C).
    10. Rojas, Diego & Vegh, Carlos & Vuletin, Guillermo, 2022. "The macroeconomic effects of macroprudential policy: Evidence from a narrative approach," Journal of International Economics, Elsevier, vol. 139(C).
    11. Gete, Pedro & Melkadze, Givi, 2020. "A quantitative model of international lending of last resort," Journal of International Economics, Elsevier, vol. 123(C).
    12. Mariarosaria Comunale, 2020. "New synchronicity indices between real and financial cycles: Is there any link to structural characteristics and recessions in European Union countries?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 25(4), pages 617-641, October.
    13. Woon Gyu Choi & Mr. David Cook, 2018. "Policy Conflicts and Inflation Targeting: The Role of Credit Markets," IMF Working Papers 2018/072, International Monetary Fund.
    14. Niels Gilbert & Sebastiaan Pool, 2020. "Sectoral allocation and macroeconomic imbalances in EMU," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 156(4), pages 945-984, November.
    15. Enrique G. Mendoza & Eugenio Rojas, 2019. "Positive and Normative Implications of Liability Dollarization for Sudden Stops Models of Macroprudential Policy," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 67(1), pages 174-214, March.
    16. Ales Marsal & Katrin Rabitsch & Lorant Kaszab, 2023. "From Linear to Nonlinear: Rethinking Inflation Dynamics in the Calvo Pricing Mechanism," Department of Economics Working Papers wuwp350, Vienna University of Economics and Business, Department of Economics.
    17. Fernando Arce & Julien Bengui & Javier Bianchi, 2023. "Overborrowing, Underborrowing, and Macroprudential Policy," Working Paper Series WP 2023-20, Federal Reserve Bank of Chicago.
    18. Nouy, D., 2017. "Safer than ever before? An assessment of the impact of regulation on banks’ resilience eight years on," Financial Stability Review, Banque de France, issue 21, pages 23-32, April.
    19. Ballouk, Hossein & Ben Jabeur, Sami & Challita, Sandra & Chen, Chaomei, 2024. "Financial stability: A scientometric analysis and research agenda," Research in International Business and Finance, Elsevier, vol. 70(PA).
    20. Donato Masciandaro, 2018. "Central Banks And Macroprudential Policies: Economics And Politics," BAFFI CAREFIN Working Papers 1878, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    21. Ouyang, Alice Y. & Guo, Shen, 2019. "Macro-prudential policies, the global financial cycle and the real exchange rate," Journal of International Money and Finance, Elsevier, vol. 96(C), pages 147-167.
    22. Nitzan Tzur-Ilan, 2019. "Macroprudential Policy: Implementation, Effects, And Lessons," Israel Economic Review, Bank of Israel, vol. 17(1), pages 39-71.
    23. Liu, Renliang & Sheng, Liugang & Wang, Jian, 2023. "Faking trade for capital control evasion: Evidence from dual exchange rate arbitrage in China," Journal of International Money and Finance, Elsevier, vol. 138(C).
    24. Wang, Jian & Wu, Jason, 2021. "Is capital flow management effective? Evidence based on U.S. monetary policy shocks," Journal of International Money and Finance, Elsevier, vol. 118(C).
    25. Akaki Tsomaia, 2021. "Asset bubbles, financial sector, and current challenges to regulatory framework," International Economics and Economic Policy, Springer, vol. 18(4), pages 901-925, October.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Enrique G. Mendoza, 2017. "Política macroprudencial: promesas y desafíos," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 20(2), pages 042-088, August.
    2. Javier Bianchi & Enrique Mendoza, 2020. "A Fisherian Approach to Financial Crises: Lessons from the Sudden Stops Literature," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 37, pages 254-283, August.
    3. Anton Korinek & Enrique G. Mendoza, 2013. "From Sudden Stops to Fisherian Deflation: Quantitative Theory and Policy Implications," NBER Working Papers 19362, National Bureau of Economic Research, Inc.
    4. Jeanne, Olivier & Korinek, Anton, 2019. "Managing credit booms and busts: A Pigouvian taxation approach," Journal of Monetary Economics, Elsevier, vol. 107(C), pages 2-17.
    5. Javier Bianchi & Enrique G. Mendoza, 2018. "Optimal Time-Consistent Macroprudential Policy," Journal of Political Economy, University of Chicago Press, vol. 126(2), pages 588-634.
    6. Jeanne, Olivier & Korinek, Anton, 2019. "Managing credit booms and busts: A Pigouvian taxation approach," Journal of Monetary Economics, Elsevier, vol. 107(C), pages 2-17.
    7. Nadav Ben Zeev, 2019. "Asymmetric Business Cycles In Emerging Market Economies," Working Papers 1909, Ben-Gurion University of the Negev, Department of Economics.
    8. Javier Bianchi, 2011. "Overborrowing and Systemic Externalities in the Business Cycle," American Economic Review, American Economic Association, vol. 101(7), pages 3400-3426, December.
    9. Juan M. Hernandez & Enrique G. Mendoza, 2017. "Optimal v. simple financial policy rules in a production economy with “liability dollarization," Revista ESPE - Ensayos sobre Política Económica, Banco de la Republica de Colombia, vol. 35(82), pages 25-39, April.
    10. Enrique G. Mendoza & Eugenio Rojas, 2019. "Positive and Normative Implications of Liability Dollarization for Sudden Stops Models of Macroprudential Policy," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 67(1), pages 174-214, March.
    11. Ottonello, Pablo, 2021. "Optimal exchange-rate policy under collateral constraints and wage rigidity," Journal of International Economics, Elsevier, vol. 131(C).
    12. Parimoo, Suneil, 2024. "Cycles and self-fulfilling crises in open economies with stock collateral constraints under impatience," Journal of Mathematical Economics, Elsevier, vol. 112(C).
    13. Ricardo M. Reyes-Heroles & Gabriel Tenorio, 2017. "Managing Capital Flows in the Presence of External Risks," International Finance Discussion Papers 1213, Board of Governors of the Federal Reserve System (U.S.).
    14. Bianchi, Javier & Liu, Chenxin & Mendoza, Enrique G., 2016. "Fundamentals news, global liquidity and macroprudential policy," Journal of International Economics, Elsevier, vol. 99(S1), pages 2-15.
    15. Korinek, Anton, 2018. "Regulating capital flows to emerging markets: An externality view," Journal of International Economics, Elsevier, vol. 111(C), pages 61-80.
    16. Liu, Zheng & Miao, Jianjun & Zha, Tao, 2016. "Land prices and unemployment," Journal of Monetary Economics, Elsevier, vol. 80(C), pages 86-105.
    17. Akıncı, Özge & Chahrour, Ryan, 2018. "Good news is bad news: Leverage cycles and sudden stops," Journal of International Economics, Elsevier, vol. 114(C), pages 362-375.
    18. Korinek, Anton & Sandri, Damiano, 2016. "Capital controls or macroprudential regulation?," Journal of International Economics, Elsevier, vol. 99(S1), pages 27-42.
    19. Laurent Clerc & Alexis Derviz & Caterina Mendicino & Stephane Moyen & Kalin Nikolov & Livio Stracca & Javier Suarez & Alexandros P. Vardoulakis, 2015. "Capital Regulation in a Macroeconomic Model with Three Layers of Default," International Journal of Central Banking, International Journal of Central Banking, vol. 11(3), pages 9-63, June.
    20. Hao Jin & Hewei Shen, 2020. "Foreign Asset Accumulation among Emerging Market Economies: a Case for Coordination," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 35, pages 54-73, January.

    More about this item

    JEL classification:

    • E0 - Macroeconomics and Monetary Economics - - General
    • F0 - International Economics - - General
    • G0 - Financial Economics - - General

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:pen:papers:16-020. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Administrator (email available below). General contact details of provider: https://edirc.repec.org/data/deupaus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.