Since the global financial crisis, macroprudential policies have joined monetary policy as an important component of policymakers’ toolkits. This has raised a series of important policy issues. How do monetary and macroprudential policy interact? Should these two instruments be seen as complements or substitutes? To what extent can domestic macroprudential policy or capital flow management measures offset monetary policy spillovers from abroad?
Despite the interest from policymakers, there is not yet a settled analytical backdrop to key aspects of the debate.1 In particular, the empirical evidence on the extent to which macroprudential policy affects the transmission of monetary policy and mitigates the propagation of shocks across borders remains scarce, particularly across a wide and diverse range of countries. The latest initiative from the International Banking Research Network (IBRN) seeks to address this empirical gap.2 This IBRN work is highly complementary to the recently launched major project by the IMF to explore how these tools can be used in an ‘Integrated Policy Framework’ (Adrian and Gopinath, 2020).
The International Banking Research Network’s common analytical approach
The IBRN initiative, recently published as a special issue of the Review of International Economics, explores how the interaction of monetary and macroprudential policy leads to policy spillovers through lending by global banks. The project builds in particular on two previous IBRN initiatives that explored, separately, the cross-border transmission of both monetary and macroprudential policy actions via bank lending (for summaries, see Buch and Goldberg, 2017, and Buch et al., 2019).
The empirical evidence is provided through six studies jointly conducted by economists from eleven central banks, spanning the experiences of the US (Liu et al. 2020); the UK and France; Germany; the Netherlands and Ireland; Chile, Mexico and Russia; and Norway and Sweden. These studies, using data from heterogeneous panels of individual reporting banks and a common empirical strategy, are complemented by a cross-country study using banking sector data aggregated at the country level by economists from the Bank for International Settlements (BIS) (Avdjiev et al. 2021).3 The participating countries differ substantially with regard to their monetary and macroprudential policy frameworks, the structure of their banking sector, and the overall macroeconomic environment. The countries include both the largest advanced economies and a number of significant emerging markets. The underlying papers use a range of specifications to identify the interaction effects of monetary and prudential policies. There are several different cases of policy interaction that teams could explore in principle, both ‘inward’ and ‘outward’, as set out in Box 1.
Specifically, the studies show the importance of understanding heterogeneity in banks’ responses to monetary and macroprudential policy actions, which in turn reflects the capital and liquidity position of individual banks, their risk profiles, access to different types of funding such as through the wholesale market, availability of collateral, or access to an internationally active banking network, which themselves are indicators of underlying market frictions.
Box 1 Schematic overview of different cases of policy interaction
Teams were encouraged to tailor their papers to aspects of particular relevance for their country. For instance, a team from country A could variously choose to look at any of the following:
- Whether the outward transmission of monetary policy from country A depends on A’s domestic macroprudential policy (case 1)
- Whether the outward transmission of monetary policy from country A depends on macroprudential policy in recipient country B (case 2)
- Whether the inward transmission of monetary policy from (systemic) country B to country A depends on macroprudential policy in source country B (case 3)
- Whether the inward transmission of monetary policy from (systemic) country B to country A depends on domestic macroprudential policy in recipient country A (case 4).
Three major themes emerge from the cross-country analytics.
1) The interactions between monetary and macroprudential policies are significant.
Macroprudential policy in recipient countries can partly offset the effects of monetary policy conducted in core countries. This result is found across emerging market economies such as Chile, Mexico and Russia and advanced countries such as Norway and Sweden. While these effects are statistically significant, the degree of offset differs across country studies, suggesting mixed effectiveness of these instruments in neutralising foreign monetary policy.
The same holds for the interaction of domestic monetary policy and macroprudential policy for smaller countries in a monetary union, though there is more differentiation in the results. Whereas the results for Ireland suggest that prudential policies dampen the transmission of euro area monetary policy to mortgage lending, mortgage credit growth of Dutch banks is influenced only by ECB monetary policy shocks and not by prudential policies.
In addition, domestic macroprudential policy in the US significantly affects the transmission of domestic monetary policy to lending abroad. This important result shows the scope for macroprudential policy in the source countries to attenuate the international spillover effects from domestic monetary policy.
2) Bank-level characteristics play a first-order role in determining cross-border transmission.
Key bank-level characteristics such as bank size or global systematically important bank (GSIB) status play a first-order role in the transmission of monetary policies.
3) Impact of macroprudential policy differs considerably across prudential policy instruments.
The impact of macroprudential policies on bank lending differs considerably across prudential policy instruments. The evidence for Ireland suggests, for instance, that notably prudential policies targeted at the lender have a significant impact on mortgage credit growth. These differences across instruments reflect, in part, the fact that certain instruments are often used for other specific purposes (for instance, some are cyclical and others are structural) and granular analysis is needed for appropriate policy design.
The research of the IBRN, across a series of initiatives, has illustrated how policy interactions affect cross-border bank flows.
In this initiative, we find that banks from core countries expand their cross-border lending, particularly to EMEs, in response to an easing in domestic monetary policy. But that expansion is less pronounced for those banks more constrained by capital, in particular via macroprudential actions taken by their domestic authorities that limit the increase in lending by less strongly capitalized banks.
Evidence from the perspective of both core and recipient countries suggests that monetary spillovers via cross-border bank lending can also be partially offset by prudential measures taken in recipient countries, though the magnitude of this offset differs. Tentative evidence shows that core countries’ prudential policies tend to have greater spillover effects than those taken by recipient countries, when interacted with core country monetary policy. This and previous IBRN initiatives consistently provide evidence of significant cross-border spillover effects of monetary and macroprudential policy action, with bank heterogeneity clearly important for understanding that transmission as well as their interactions.
Authors’ note: This column is based on Bussiere et al. (2021a), the overview paper for the IBRN’s project, written jointly with Jin Cao (Norges Bank), Simon Lloyd (Bank of England), Baptiste Meunier (Banque de France), Justine Pedrono (Banque de France), Dennis Reinhardt (Bank of England), Sonalika Sinha (Reserve Bank of India), Rhiannon Sowerbutts (Bank of England) and Konstantin Styrin (Bank of Russia).The views expressed in this column are solely those of the authors and should not be interpreted as reflecting those of any organisation with which they are associated.
Adrian, T and G Gopinath (2020), “Toward an integrated policy framework for open economies”, IMFBlog, 13 July.
Avdjiev, S, B Hardy, P McGuire and G von Peter (2021), “Home sweet host: Prudential and monetary policy spillovers through global banks”, Review of International Economics 29(1): 20-36.
Bruno, V and H S Shin (2015), “Cross-border banking and global liquidity”, Review of Economic Studies 82: 535–564.
Buch, C M, M Bussière, L Goldberg and R Hills (2019), “The international transmission of monetary policy", Journal of International Money and Finance 91: 29-48.
Buch, C M and L Goldberg (2017), “Cross-border prudential policy spillovers: How much? How important? Evidence from the International Banking Research Network", International Journal of Central Banking 13(Supplement): 5-34.
Bush, G, T Gomez, A Jara, C Lopez-Castanon, D Moreno, K Styri and Y Ushakova (2021), “Macroprudential policy and the inward transmission of monetary policy shocks: The case of Chile, México, and Russia”, Review of International Economics 29(1): 37-60.
Bussière, M, J Cao, J de Haan, R Hills, S Lloyd, B Meunier, J Pedrono, D Reinhardt, S Sinha, R Sowerbutts, and K Styrin (2021a), “The Interaction between Macroprudential Policy and Monetary Policy: Overview”, Review of International Economics 29(1): 1-19.
Bussière, M, R Hills, S Lloyd, B Meunier, J Pedrono, D Reinhardt and R Sowerbutts (2021b), “Le Pont de Londres: interactions between monetary and prudential policies in cross-border lending”, Review of International Economics 29(1): 61-86.
Cao, J, V Dinger, A Grodecka-Messi, R Juelsrud and X Zhang (2021), “The interaction between macroprudential and monetary policies: The cases of Norway and Sweden”, Review of International Economics 29(1): 87-116.
Everett, M, J de Haan, D Jansen P McQuade and A Samarina (2021), “Mortgage lending, monetary policy, and prudential measures in small euro-area economies: Evidence from Ireland and the Netherlands”, Review of International Economics 29(1): 117-143.
Imbierowicz, B, A Löffle and U Vogel (2021), “The transmission of bank capital requirements and monetary policy to bank lending”, Review of International Economics 29(1): 144-164.
Liu, E, F Niepmann and T Schmidt-Eisenlohr (2020), “Stress tests can limit international spillovers of accommodative monetary policy”, VoxEU.org, 2 February.
Maddaloni, A and J L Peydro, (2013), “Monetary policy, macroprudential policy and banking stability: Evidence from the euro area”, International Journal of Central Banking 9: 121-169.
Miranda-Agrippino, S and H Rey (2020), “US monetary policy and the global financial cycle”, Review of Economic Studies 87(6): 2754-2776.
Niepmann, F, T Schmidt-Eisenlohr and E Liu (2021), “The effect of U.S. stress tests on monetary policy spillovers to emerging markets”, Review of International Economics 29(1): 165-194.
Takáts, E and J Temesvary (2019), “Can macroprudential measures make cross-border lending more resilient?”, International Journal of Central Banking 15: 61-105.
1 In the literature, there is a lively discussion on the extent to which there is a global financial cycle, driven by core country monetary policy (e.g. Miranda-Agrippino and Rey 2020), and the trade-offs this poses for policymakers (e.g. Bruno and Shin, 2015). There is a body of evidence on how prudential policy affects the domestic transmission of monetary policy (e.g. Maddaloni and Peydro, 2013) and an emerging strand on how prudential policies can offset the unintended consequences of monetary policy (e.g. Takáts and Temesvary, 2019).
2 This is the IBRN’s fourth project; the policy lessons of the first three are described in previous VoxEU columns (Buch et al. 2014, 2016, 2018).
3 The country studies are Bush et al. (2021), Bussière et al. (2021b), Cao et al. (2021), Everett et al. (2021), Imbierowicz et al. (2021) and Niepmann et al. (2021). The special issue can be found on the website of the Review of International Economics.