## CHAPTER 3 — Dampening Global Financial Shocks in Emerging Markets: Can Macroprudential Regulation Help?

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### Background and research objective
- Fluctuations in global financial markets have historically significantly influenced financial and macroeconomic conditions in emerging markets.
- The tightening in global financial markets caused by the COVID-19 pandemic is placing emerging markets under severe distress: capital flows to emerging markets are rapidly receding while global risk aversion has spiked.
- Premise: by reinforcing balance sheets, restricting risk taking, and limiting foreign currency exposures, macroprudential regulation strengthens domestic financial-sector resilience and thus enhances macroeconomic stability.
- Research question: Can a more stringent level of macroprudential regulation dampen the effects of global financial shocks on macroeconomic conditions in emerging markets? Secondary questions examine whether tighter macroprudential regulation allows more countercyclical monetary policy responses and whether there are side effects on average growth and cross-country spillovers.

### Data, sample, and empirical framework
- Sample: 38 emerging markets between 2000 and 2016 (based on data availability). Country list includes Albania, Argentina, Belarus, Bosnia and Herzegovina, Brazil, Bulgaria, Chile, China, Colombia, Costa Rica, Croatia, the Dominican Republic, Ecuador, El Salvador, Georgia, Hungary, India, Indonesia, Jamaica, Jordan, Kazakhstan, Malaysia, Mexico, Morocco, North Macedonia, Pakistan, Paraguay, Peru, the Philippines, Poland, Romania, Russia, Serbia, South Africa, Thailand, Turkey, Ukraine, and Uruguay.
- Sample period ends in 2016—the last year in the iMaPP database—and excludes extreme crises characterized by a “freely falling” exchange rate (Ilzetzki, Reinhart, and Rogoff 2019).
- Macroprudential index: cumulated net tightening actions since 1990 from the IMF iMaPP database (Alam and others 2019); cumulated indices are rescaled to be always positive because squared values enter regressions.
- Global shocks considered:
  - US monetary policy shocks (residuals from a regression of the federal funds rate on US inflation, US log GDP, US corporate spreads, and the log of foreign GDP); US policy rate uses the federal funds rate except during the zero lower bound period, which uses the implied rate from Wu and Xia (2015/2016).
  - VIX (Chicago Board Options Exchange Volatility Index) to capture global risk premia.
  - Net capital inflows (in percent of GDP), instrumented using the sum of gross capital inflows to other emerging markets and normalized by the Hodrick-Prescott-trend component of GDP.
- Empirical strategy: panel regressions of quarterly real GDP growth (and of policy rates or credit outcomes) on global shocks, interactions with the level (and squared level) of macroprudential regulation, country fixed effects, and controls (lagged GDP growth, lagged log real GDP per capita, institutional quality, lagged output gap, commodity terms of trade, expected inflation, real credit growth, etc.).

### Key empirical findings — macroeconomic resilience and growth
- Macroprudential regulation reduces the sensitivity of GDP growth in emerging markets to global financial shocks.
  - At low levels of macroprudential regulation, a 60 percent spike in the VIX, or a capital outflow equal to 2 percent of GDP, can push emerging markets with the lowest levels of macroprudential regulation into recession (quarterly GDP growth in the sample averages 1 percent).
  - Once the VIX and net capital flows are controlled for, shocks to US policy rates appear not to have statistically significant effects on emerging markets’ economic growth.
- Dampening effects are statistically significant for Ln VIX and Net Outflows, but not for US Rate (panel results and robustness tables).
- Dampening effects exhibit decreasing marginal returns: when regulation is already more stringent, further tightening becomes less effective at strengthening resilience.
- Macroprudential regulation has symmetric effects on economic activity:
  - A higher level of macroprudential regulation supports GDP growth when global financial shocks are adverse.
  - The same higher level lowers economic activity when global financial conditions are favorable.
  - A Wald test indicates dampening effects against positive and negative shocks are not statistically different from one another.
- Counterfactual prediction (2000–16 coefficients): higher regulation (75th percentile vs 25th percentile) would have:
  - Increased quarterly GDP growth by about 0.6 percent between Q4 2008 and Q2 2009.
  - Lowered economic growth considerably in the years before the global financial crisis (when conditions were buoyant).
  - Reduced the standard deviation of GDP growth during 2000–16 by about 20 percent relative to the 25th percentile.
  - No statistically significant effect on average GDP growth during 2000–16 (Panel 3 of Figure 3.8).

### Which macroprudential measures matter; effects on credit and exchange rates
- Decomposition of the iMaPP index into categories: bank capital and liquidity; credit demand (loan-to-value and similar); credit supply (limits on credit growth); foreign currency exposure.
- Findings (reference shocks: Ln VIX and net capital outflows):
  - Measures targeted at credit demand, foreign currency exposure, and liquidity offer protection against fluctuations in the VIX.
  - Measures targeted at bank capital, credit demand, and credit supply protect against shocks to net capital flows.
- Macroprudential regulation weakens the effects of capital flow shocks on the real growth of bank credit, consistent with stronger bank capital and liquidity and reduced currency mismatches making banks less susceptible to foreign funding swings.
- Macroprudential regulation tends to dampen effects of VIX and capital flow shocks on nominal and real effective exchange rates, possibly via reduced volatility of currency risk premia.

### Interaction with monetary policy and official reserves
- Monetary policy response regressions (restricted to flexible exchange rate periods) show:
  - At low macroprudential stringency, emerging markets tighten policy in response to a 1 percentage point US rate hike or a 10 percent VIX increase.
  - A more stringent level of macroprudential regulation dampens this procyclical tightening; at sufficiently high levels, central banks can react countercyclically by lowering policy rates—especially in response to VIX increases.
  - Macroprudential regulation has no statistically significant effect on the response of monetary policy to capital outflow shocks; capital outflows trigger monetary tightening independent of macroprudential stringency.
- Annex Table 3.3.3 and narrative: a higher stock of official reserves supports a more countercyclical response of monetary policy to changes in US policy rates, plausibly by enabling foreign exchange intervention; robustness table entries for Official Reserves are US Rate: n.s.; Ln VIX: ; Net Outflows: n.s.

### Spillovers, leakages, and cross-border effects
- No evidence of negative cross-country spillovers from higher macroprudential stringency; instead:
  - Positive spillovers are observed for shocks to net capital flows (consistent across geographic, income, and risk groupings).
  - Interaction regressions use average macroprudential regulation in other emerging markets weighted by gross capital inflow shares.
- Meta-analysis evidence (Araujo and others, forthcoming) of 58 studies indicates macroprudential tightening tends to be associated with leakages through increases in cross-border or non-bank lending, though tightening still tends to constrain credit growth overall.

### Robustness tests and endogeneity considerations
- Measurement issues:
  - iMaPP records tightenings/loosens but not intensity (except loan-to-value limits), and the cumulated index gives equal weight to heterogeneous measures; countries may have different baselines in 1990.
- Reverse causality and persistence:
  - The cumulated index is persistent and much less volatile than quarterly GDP growth; robustness tests include excluding negative-GDP-growth periods, lagging macroprudential regulation by one quarter and one year, and using average regulation (2000–16).
  - Across specifications, dampening effects for Ln VIX and Net Outflows remain significant; US Rate effects remain n.s.
- Omitted-variable robustness:
  - Augmenting regressions with interactions between shocks and country structural characteristics, fiscal and monetary variables, exchange rate regime, capital controls, official reserves, and time fixed effects does not eliminate the dampening effects for Ln VIX and Net Outflows.
  - Exception: controlling for official reserves can attenuate the effect of macroprudential regulation on the monetary policy response to US policy rate changes.
- Remaining limitations:
  - Measurement shortcomings likely bias results against finding significant effects but remain a limitation.
  - Endogeneity concerns are more severe for testing average-growth effects; further research and improved measurement of macroprudential intensity are needed.

### Policy implications and recommendations
- Macroprudential regulation can be an effective tool to dampen transmission of adverse global financial shocks to emerging-market macroeconomic conditions, but design and calibration matter.
- Priorities for policymakers:
  - Recognize trade-offs from symmetric dampening: durable high macroprudential stringency cushions adverse shocks but can lower activity when global conditions are favorable.
  - Account for decreasing marginal returns and circumvention risks (shadow banking, international lenders) when tightening further in already-stringent environments.
  - Improve measurement of macroprudential regulation (intensity and heterogeneity of tools).
  - Explore complementarities and interactions among macroprudential tools, capital controls, foreign exchange intervention, and monetary policy in richer empirical frameworks.
  - Monitor potential circumvention channels as stringency increases and consider complementary tools (foreign exchange intervention, capital flow management) especially under sharp capital outflows.
- Suggested research avenues:
  - Optimal, state-dependent adjustment of macroprudential regulation to balance dampening negative shocks without unduly constraining activity when conditions are supportive.
  - Whether prompt adjustment (for example, easing when adverse shocks hit) can offset shocks.
  - Better characterization of transmission channels linking specific macroprudential measures to outcomes (credit growth stabilization, exchange rate stabilization, enabling countercyclical monetary policy).

### Box and meta-analysis takeaways
- Box 3.1 meta-analysis main result: macroprudential tightening reduces credit by 0.04 standard deviation on average—about a 0.6 percentage point reduction in year-over-year growth of real credit (quarterly frequency), using an average standard deviation of 13 percent.
- Housing and liquidity-based measures show larger average effects in emerging markets (with wider confidence intervals); studies using microdata find stronger effects than aggregate-data studies.
- Box 3.2 and related regressions show emerging-market policymakers tend to loosen macroprudential policies when global financial conditions tighten (US rate, VIX, net outflows coefficients in ∆MPru regressions are negative and statistically significant), a pattern observed during the COVID-19 episode.

*Source: IMF staff analysis in Chapter 3, April 2020.*

### Introduction

### ch3 - Introduction

### Background: global financial shocks and emerging markets
- Fluctuations in global financial markets have historically significantly influenced financial and macroeconomic conditions in emerging markets.
- Under buoyant global financial conditions, emerging markets have enjoyed stronger economic growth supported by abundant foreign capital inflows; when global financial conditions tightened—most notably during the global financial crisis—economic activity in emerging markets was severely affected.
- The tightening in global financial markets caused by the COVID-19 pandemic is again placing emerging markets under severe distress: capital flows to emerging markets are rapidly receding while global risk aversion has spiked.
- Conventional macroeconomic theory suggests exchange rate flexibility should largely offset global financial shocks, and evidence indicates exchange rate flexibility softens effects (Obstfeld, Ostry, and Qureshi 2019), but it does not provide full insulation. Global financial conditions affect credit markets and macroeconomic conditions even in countries with flexible exchange rates (Rey 2015, 2016).

### Role of macroprudential regulation and research objective
- Growing awareness that macroprudential policies can play an important role in stabilizing credit markets, despite heterogeneity in effectiveness among instruments.
- Premise: by reinforcing balance sheets, restricting risk taking, and limiting foreign currency exposures, macroprudential regulation strengthens domestic financial-sector resilience and thus enhances macroeconomic stability.
- The chapter analyzes whether emerging markets that have adopted a tighter level of macroprudential regulation may be able to withstand more effectively the macroeconomic impacts of global financial shocks.
- The analysis focuses on whether a tighter level of macroprudential regulation—which is expected to strengthen financial resilience—dampens the effects of global financial shocks on domestic macroeconomic conditions (distinct from analyzing changes in regulation).

### Data, sample, and measurement
- Sample: 38 emerging markets between 2000 and 2016 (based on data availability). The country sample includes Albania, Argentina, Belarus, Bosnia and Herzegovina, Brazil, Bulgaria, Chile, China, Colombia, Costa Rica, Croatia, the Dominican Republic, Ecuador, El Salvador, Georgia, Hungary, India, Indonesia, Jamaica, Jordan, Kazakhstan, Malaysia, Mexico, Morocco, North Macedonia, Pakistan, Paraguay, Peru, the Philippines, Poland, Romania, Russia, Serbia, South Africa, Thailand, Turkey, Ukraine, and Uruguay.
- Sample period ends in 2016—the last year in the iMaPP database—and excludes extreme crises characterized by a “freely falling” exchange rate (Ilzetzki, Reinhart, and Rogoff 2019).
- Macroprudential actions: IMF’s integrated Macroprudential Policy (iMaPP) database records tightening and loosening actions for various macroprudential policy instruments between 1990 and 2016 (Alam and others 2019). The level of macroprudential regulation is calculated by cumulating net tightening actions for each country since 1990.
- Global risk aversion proxied by the Chicago Board Options Exchange Volatility Index (VIX); US policy rate uses the federal funds rate except during the zero lower bound period, which uses the implied rate from Wu and Xia (2015).

### Research questions (as posed in the chapter)
- Can a more stringent level of macroprudential regulation dampen the effects of global financial shocks on macroeconomic conditions in emerging markets?
- Regarding possible channels through which macroprudential regulation affects resilience, does monetary policy respond more countercyclically to global financial shocks when macroprudential regulation is tighter?
- Does macroprudential regulation have side effects on average economic growth and via cross-country spillovers?

### Key findings
- Macroprudential regulation can strengthen emerging markets’ resilience to swings in global financial conditions.
- A more stringent level of macroprudential regulation reduces the sensitivity of GDP growth in emerging markets to global financial shocks.
- Results are robust to a broad set of endogeneity tests to alleviate concerns about reverse causality and omitted variables.
- Dampening effects exhibit decreasing marginal returns: when regulation is already more stringent, further tightening becomes less effective in strengthening resilience—consistent with concerns about circumvention and migration of activities outside the regulatory perimeter and increased cross-border lending.
- No particular set of tools exclusively drives the dampening effects: a broad range of macroprudential measures can enhance resilience, including tools that boost bank capital and liquidity, limit foreign exchange exposures, and prevent risky lending to leveraged borrowers. However, these tools have heterogeneous dampening effects depending on the type of global financial shock.
- Macroprudential regulation appears to:
  - Reduce domestic credit’s sensitivity to global financial shocks, consistent with stronger bank balance sheets leading to steadier credit supply.
  - Tend to stabilize nominal and real exchange rates, possibly because a safer financial system reduces the volatility of currency risk premia.
- Macroprudential regulation has symmetric effects on economic activity:
  - A higher level of macroprudential regulation supports GDP growth when global financial shocks are adverse.
  - The same higher level lowers economic activity when global financial conditions are favorable.
- These symmetric effects imply costs to maintaining a high level of macroprudential regulation at all times and call for analysis of optimal adjustment of macroprudential policies to balance dampening negative shocks without unduly constraining activity when conditions are supportive.

### Implications and directions for further analysis
- Policy implication: macroprudential regulation can be an effective tool to dampen the transmission of adverse global financial shocks to emerging-market macroeconomic conditions, but its design and calibration matter.
- Need to consider decreasing marginal returns and circumvention risks when tightening regulation further in already-stringent environments.
- Further research should examine how to optimally adjust macroprudential policies over time, taking into account domestic systemic vulnerabilities (IMF 2014) and the heterogeneity of instrument effects by shock type.

*Source: ch3 - Introduction (PDF).*

### Box 3.2 shows that policymakers in emerging markets tend to

### ch3 - Box 3.2 shows that policymakers in emerging markets tend to

### Research question and motivation
- Investigates whether the level of macroprudential regulation mediates the impact of global financial shocks on emerging markets’ GDP.
- Motivated by the hypothesis that macroprudential regulation buttresses financial sector stability (higher bank capital and liquidity, reduced leverage, fewer currency mismatches) and thus enhances macroeconomic resilience to global shocks.
- Policy trade-off highlighted: emerging market central banks face a tension between extraordinary monetary easing to offset severe declines in domestic and foreign demand and the risk that such easing exacerbates destabilizing capital outflows and exchange rate depreciations.

### Empirical framework
- Uses a panel regression of real GDP growth in emerging markets on a vector of global financial shocks and their interactions with the stringency of macroprudential regulation.
- Global financial shocks considered:
  - US monetary policy shocks (residuals from a regression of the federal funds rate on US inflation, US log GDP, US corporate spreads, and the log of foreign GDP).
  - VIX (to capture changes in global risk premia).
  - Net capital inflows (in percent of GDP), instrumented using the sum of gross capital inflows to other emerging markets and normalized by the Hodrick-Prescott-trend component of GDP.
- Stringency of macroprudential regulation measured by cumulating net tightening actions for each country since 1990 (iMaPP database); cumulated indices are rescaled to be always positive because squared values enter the regression.
- Regression controls include country fixed effects and additional controls such as lagged GDP growth, lagged log real GDP per capita, institutional quality, lagged output gap, commodity terms of trade, among others.
- Interaction terms with the squared level of macroprudential regulation included to allow for nonlinear effects.
- Identification choices: including all three shocks jointly to disentangle risk-free rates, risk premia, and quantity supply of foreign capital.

### Key empirical findings
- Macroprudential regulation dampens the impact of global financial shocks on GDP in emerging markets.
  - At low levels of macroprudential regulation, a 60 percent spike in the VIX, or a capital outflow equal to 2 percent of GDP, can push emerging markets with the lowest levels of macroprudential regulation into recession (quarterly GDP growth in the sample averages 1 percent).
  - Once the VIX and net capital flows are controlled for, shocks to US policy rates appear not to have statistically significant effects on emerging markets’ economic growth.
  - The coefficients on the interaction terms between the shock and macroprudential regulation are statistically significant in panel 2 (VIX) and panel 3 (net outflows), but not in panel 1 (US rate hike).
- Monetary policy behavior in the ongoing global crisis:
  - Between March 1 and April 10 2020, the United States has reduced the policy rate by 150 basis points while the emerging markets considered in the analysis have, on average, lowered rates by about 55 basis points.
- Distribution and nonlinearities:
  - Emerging markets have generally tightened macroprudential policies over time (distribution shifts right during 2000–16 and at end-2016), though various countries remain at levels where further tightening can strengthen resilience.
  - Dampening effects exhibit nonlinearities: a tightening in macroprudential regulation becomes progressively less effective in strengthening resilience to global financial shocks at higher levels of stringency.
  - Potential explanation: circumvention through shadow banking or international lenders may weaken effectiveness as regulation tightens.

### Robustness tests and caveats
- Measurement concerns with the macroprudential index:
  - iMaPP database records tightenings/loosens but not intensity (except loan-to-value limits).
  - Cumulated index gives equal weight to heterogeneous measures.
  - Countries may have started with different baseline levels in 1990.
- Reverse causality and persistence:
  - Level of macroprudential regulation is persistent and much less volatile than quarterly GDP growth; cumulated index is largely predetermined relative to shocks.
  - Robustness tests include excluding periods with negative GDP growth, lagging macroprudential regulation by one quarter and one year, and using the average level of macroprudential regulation for 2000–16 to rely on cross-country heterogeneity only.
  - Table 3.1 summary (check marks denote a statistically significant dampening effect at the 10 percent level):
    - Baseline: US Rate n.s.; Ln VIX ; Net Outflows 
    - Excluding Negative GDP Growth: US Rate n.s.; Ln VIX ; Net Outflows 
    - Macroprudential Regulation, One Quarter Lagged: US Rate n.s.; Ln VIX ; Net Outflows 
    - Macroprudential Regulation, One Year Lagged: US Rate n.s.; Ln VIX ; Net Outflows 
    - Average Macroprudential Regulation: US Rate n.s.; Ln VIX ; Net Outflows 
- Omitted-variable concerns:
  - Regression augmented with interactions between shocks and country structural characteristics, fiscal variables, monetary policy variables, exchange rate regime, capital controls, and official reserves.
  - Table 3.2 summary (check marks denote a statistically significant dampening effect at the 10 percent level):
    - Baseline: US Rate n.s.; Ln VIX ; Net Outflows 
    - Institutional Quality: US Rate n.s.; Ln VIX ; Net Outflows 
    - Financial Development: US Rate n.s.; Ln VIX ; Net Outflows 
    - Gross Public Debt: US Rate n.s.; Ln VIX ; Net Outflows 
    - Gross Public Debt in Foreign Currency: US Rate n.s.; Ln VIX ; Net Outflows 
    - Cyclically Adjusted Balance: US Rate n.s.; Ln VIX ; Net Outflows 
    - Monetary Policy Rate: US Rate n.s.; Ln VIX ; Net Outflows 
    - Inflation Expectation Anchoring: US Rate n.s.; Ln VIX ; Net Outflows 
    - Fixed Exchange Rate Regime: US Rate n.s.; Ln VIX ; Net Outflows 
    - Capital Controls: US Rate n.s.; Ln VIX ; Net Outflows 
    - Official Reserves: US Rate n.s.; Ln VIX ; Net Outflows 
    - Time Fixed Effects: US Rate n.s.; Ln VIX ; Net Outflows 
  - Inclusion of these controls and time fixed effects does not eliminate the dampening effects for VIX and net outflows.
- Remaining limitations:
  - Measurement shortcomings likely bias results against finding significant effects, but they remain a limitation.
  - Endogeneity concerns are more severe for testing whether macroprudential regulation affects average growth across the cycle; the chapter finds no evidence that stricter macroprudential regulation reduces average economic growth, but calls for more research.
  - Need for improved measurement of macroprudential intensity, richer empirical frameworks allowing dynamic effects and fuller interplay among policy tools, and systematic analysis of interactions among macroprudential measures, capital controls, and foreign exchange intervention.

### Policy implications and interpretation
- Macroprudential regulation appears to permit more countercyclical monetary policy responses to spikes in global risk aversion:
  - In countries with tighter macroprudential regulation, central banks tend to cut policy rates more aggressively when global risk aversion spikes, supporting domestic demand—consistent with macroprudential measures alleviating financial stability concerns and allowing monetary policy to focus on macroeconomic stabilization.
- Macroprudential regulation does not show evidence of causing negative cross-country spillovers; instead, there is some evidence of positive spillovers where higher macroprudential stringency in one country enhances macroeconomic stability in others facing capital flow shocks.
- Gains from further tightening are present but modest, and marginal effectiveness declines at higher levels of stringency.
- Policy design priorities:
  - Improve measurement of macroprudential regulation (intensity and heterogeneity of tools).
  - Explore complementarities and interactions between macroprudential tools, capital controls, foreign exchange intervention, and monetary policy in richer empirical frameworks.
  - Monitor potential circumvention channels (shadow banking, international lending) as macroprudential stringency increases.

*Source: IMF staff analysis in Chapter 3, April 2020.*

### CHAPTER 3

### CHAPTER 3

### Symmetric dampening effects of macroprudential regulation
- Macroprudential regulation entails symmetric dampening effects of a similar magnitude against positive and negative global financial shocks; a Wald test confirms the dampening effects against positive and negative global financial shocks are not statistically different from one another.
- Implication: maintaining a high level of macroprudential regulation supports resilience in cases of negative financial shocks but also lowers economic activity when global financial shocks are positive, implying a trade-off in forgoing growth opportunities when global financial conditions are favorable.
- Policy consideration: policymakers should not necessarily wait to tighten macroprudential regulation only after global conditions deteriorate because constraining excessive risk taking and credit provision when financial conditions are loose is a key channel to ensure greater resilience at times of financial distress.
- Calls for further analysis on how to adjust regulation optimally to dampen negative shocks without excessively constraining activity when conditions are supportive.

### Which macroprudential measures drive the dampening?
- The overall index from the iMaPP database is decomposed into categories: bank capital and liquidity, credit demand (such as loan-to-value ratios), credit supply (such as limits on credit growth), and foreign currency exposure.
- Findings (Figure 3.5; reference shocks: Ln VIX and net capital outflows):
  - Measures targeted at credit demand, foreign currency exposure, and liquidity offer protection against fluctuations in the VIX.
  - Macroprudential regulation targeted at bank capital, credit demand, and credit supply protects against shocks to net capital flows.
- Conclusion: enhancing resilience to global financial shocks requires a well-rounded macroprudential framework rather than a narrow focus on a few specific tools.
- Note: the dampening effects are not limited to measures targeted at foreign currency exposures that could operate similarly to capital flow management measures; for the country sample, the IMF 2019 Taxonomy identifies only nine macroprudential actions also classified as capital flow management measures, of which seven are recorded in iMaPP; results are robust to excluding those measures.

### Effects on credit and exchange rates
- Macroprudential policies weaken the effects of capital flow shocks on the real growth of bank credit (Figure 3.6).
  - Interpretation: by boosting bank capital and liquidity and reducing currency mismatches, macroprudential regulation makes the banking sector less susceptible to fluctuations in the supply of foreign funds.
- Macroprudential regulation tends to dampen the effects of VIX and capital flow shocks on the nominal and real effective exchange rates.
  - Possible channel: curbing domestic risk taking reduces volatility of currency risk premia, which can contribute to more stable growth by weakening damaging effects of currency mismatches and allowing more countercyclical monetary policy responses.
- Technical notes on figures and estimation:
  - Visualization uses the level of macroprudential regulation divided by 10 to ease coefficient visualization.
  - In some figure notes: "In the case of Ln VIX, the shock is a 1 percent increase in the VIX; for net outflows, the shock consists of a 5 percentage point increase in net outflows." Elsewhere figure panels refer to a "10 Percent VIX Increase" and a "1 Percentage Point Change in Net Outflows."
  - Vertical lines correspond to 90 percent confidence intervals computed with Driscoll-Kraay standard errors.

### Can macroprudential regulation support a more countercyclical monetary policy response?
- The trilemma context: countries open to capital flows can retain monetary independence if they have a flexible exchange rate; however, many emerging markets with flexible exchange rates still tighten policy rates in response to US monetary tightening or VIX spikes, operating procyclically.
- Empirical approach:
  - Analysis restricts to periods with flexible exchange rates.
  - Policy rates are regressed on global financial variables—US monetary policy (actual US policy rates adjusted for unconventional policy using implied rate from Wu and Xia (2016)), the VIX, and instrumented net capital outflows—and their interactions with macroprudential stringency.
  - Controls include country fixed effects, domestic output gap, expected inflation, real credit growth, and commodity terms of trade.
- Findings (Figure 3.7):
  - At low levels of macroprudential regulation, emerging markets tighten monetary policy in response to a 1 percentage point US rate hike or a 10 percent VIX increase.
  - A more stringent level of macroprudential regulation dampens this procyclical response; a sufficiently high level allows central banks in emerging markets to react countercyclically by lowering policy rates especially in response to an increase in the VIX.
  - Macroprudential regulation has no statistically significant effect on the response of monetary policy to capital outflow shocks; capital outflows trigger monetary tightening independent of the macroprudential regulation level.
- Implication: even with tight macroprudential regulation, central banks face trade-offs when responding to sharp capital flow fluctuations; additional tools such as foreign exchange intervention might be required in disorderly conditions.

### Robustness to endogeneity and omitted variables
- Reverse causality concern: macroprudential regulation could be adjusted in reference to domestic policy rates; in the regression sample, macroprudential regulation tends to be loosened when monetary policy is tightened.
- Tests performed:
  - Regression replication using macroprudential regulation lagged by one quarter and one year, and using average level of regulation (purely cross-sectional identification).
  - Table 3.3 results (check marks indicate significantly more countercyclical response at the 10 percent significance level; n.s. = nonsignificant):
    - Baseline: US Rate ; Ln VIX ; Net Outflows n.s.
    - Macroprudential Regulation, One Quarter Lagged: US Rate ; Ln VIX ; Net Outflows n.s.
    - Macroprudential Regulation, One Year Lagged: US Rate ; Ln VIX ; Net Outflows n.s.
    - Average Macroprudential Regulation: US Rate n.s.; Ln VIX ; Net Outflows 
  - Interpretation: across these specifications, macroprudential regulation continues to support a more countercyclical response of monetary policy to global financial conditions. The average-level specification shifts the effect toward capital flow shocks rather than US policy changes.
- Omitted-variable robustness:
  - Augmenting the regression with interactions of global shocks with country characteristics and policy variables—one at a time—including institutional quality, financial development, gross public debt, gross public debt in foreign currency, the cyclically adjusted fiscal balance, anchoring of inflation expectations, capital controls, and level of official reserves—shows that macroprudential regulation generally continues to support more countercyclical monetary responses to US policy rates and the VIX.
  - Exception: when the level of official reserves is controlled for, macroprudential regulation no longer affects the monetary policy response to changes in US policy rates.
  - Results are robust to inclusion of time fixed effects.
- Additional technical notes:
  - The regression uses actual US policy rates rather than unexpected shocks because emerging markets in the sample tend to adjust policy rates in reference to actual US policy rates.
  - The US policy rate is adjusted for unconventional policy during the zero-lower-bound period using the implied rate from Wu and Xia (2016).

*Source: CHAPTER 3, DaMPENING GLOBaL FINaNCIaL ShOCKS IN EMERGING MaRKETS: CaN MaCROPRUDENTIaL REGULaTION hELP?, International Monetary Fund | April 2020*

### Annex Table 3.3.3 shows that a higher stock of official reserves

### ch3 - Annex Table 3.3.3 shows that a higher stock of official reserves

### Official reserves and monetary policy
- Annex Table 3.3.3 (stated in the source) shows that a higher stock of official reserves supports a more countercyclical response of monetary policy in emerging markets to changes in US policy rates, possibly because it allows for more decisive foreign exchange intervention.
- Robustness tests cannot easily control for foreign exchange intervention because the decision to intervene is highly endogenous as it depends on global financial shocks and their expected impact on the economy.
- Table 3.4 (Robustness to Omitted Variables: Supporting Countercyclical Monetary Response) reports the significance of additional controls on the monetary policy response to three global financial shocks (US Rate, Ln VIX, Net Outflows). For Official Reserves the entries are:
  - US Rate: n.s.
  - Ln VIX: 
  - Net Outflows: n.s.
- Implication from the chapter: macroprudential regulation may permit monetary policy to respond more countercyclically (for example, by allowing lower policy rates when the VIX increases), and official reserves are identified in the narrative as a channel enabling foreign exchange intervention, even though the specific robustness table entries for Official Reserves are as listed above.

### Effects on Economic Growth
- Macroprudential regulation has symmetric dampening effects:
  - It sustains growth when global financial shocks are adverse.
  - It reduces economic activity when financial conditions are supportive.
- Potential negative mechanisms:
  - Excessively tight macroprudential regulation could constrain credit provision or lead to suboptimal risk taking, lowering average growth.
- Potential positive mechanisms:
  - Macroprudential regulation might improve average growth via more efficient allocation of credit, mobilizing savings, and reducing permanent GDP losses from financial crises (Agénor 2019; Ma 2020).
- Empirical literature is mixed:
  - Some studies find temporary GDP declines after tightening (Eickmeier, Kolb, and Prieto 2018; Kim and Mehrotra 2018; Richter, Schularick, and Shim 2019).
  - Others find positive longer-term effects on growth (Boar and others 2017; Agénor and others 2018; Neanidis 2019).
- Counterfactual prediction using estimated regression coefficients (2000–16) comparing high (75th percentile) vs low (25th percentile) macroprudential regulation:
  - Higher regulation would have increased quarterly GDP growth by about 0.6 percent between the fourth quarter of 2008 and the second quarter of 2009.
  - Higher regulation would have lowered economic growth considerably in the years before the global financial crisis (when conditions were buoyant).
  - A higher level of macroprudential regulation at the 75th percentile would have reduced the standard deviation of GDP growth during 2000–16 by about 20 percent relative to the 25th percentile.
  - Panel 3 of Figure 3.8: During 2000–16, a higher level of regulation would have had no statistically significant effect on average GDP growth.
- Caveats and limitations:
  - Negative effects on average growth could materialize at regulation levels above those observed in the sample.
  - Reverse causality is a concern (authorities may tighten regulation when growth is greater and vice versa), though stickiness of regulation and limited use of macroprudential policies in response to GDP reduce this concern.
  - The analysis of dampening effects is less vulnerable to reverse causality because it uses the average level of macroprudential regulation for each country; the growth effect analysis cannot use this approach because country fixed effects absorb cross-country differences in average regulation.
  - Further analysis is needed to establish causal effects on average GDP growth.

### Cross-Country Spillovers
- The chapter examines whether tighter macroprudential regulation in one country causes harmful cross-border spillovers (for example, relocation of risky activities).
- Two possible directions:
  - Negative spillovers: relocation of risky financial activities to other countries, increasing their susceptibility to global shocks.
  - Positive spillovers: greater stability in trade and financial links from a more resilient country, benefiting other countries.
- Empirical approach:
  - Regression expanded to include interaction terms of global financial shocks with the average level of macroprudential regulation in other emerging markets (average weighted by gross capital inflow shares).
  - Countries grouped three ways: same geographic region, same income class (above/below median GDP per capita in the sample in any year), same risk class (based on a composite risk index).
- Findings (Figure 3.9):
  - No evidence of spillovers associated with shocks to US monetary policy and the VIX (interaction coefficients statistically nonsignificant).
  - Positive spillovers associated with shocks to net capital flows (consistent across geographic, income, and risk groupings).
  - Overall conclusion: no evidence of negative cross-country spillovers; some evidence of positive cross-country spillovers from macroprudential regulation, particularly for capital flow shocks.

### Conclusion and policy implications
- Core result: tighter macroprudential regulation reduces the sensitivity of GDP growth in emerging markets to fluctuations in risk premia and changes in foreign capital flows.
- Dampening effects are not tied to a single tool; a broad range of measures (targeting liquidity, capital, foreign exchange exposures, and risky credit) contribute, though tool effects are heterogeneous by shock type.
- Macroprudential regulation also helps stabilize real credit growth and nominal and real exchange rates.
- Trade-offs:
  - Permanent high levels of macroprudential regulation impose costs via symmetric dampening (attenuating negative impacts of adverse shocks but limiting growth in buoyant times).
  - This suggests research into optimal, state-dependent adjustment of macroprudential regulation.
- Interaction with monetary policy:
  - One channel is enabling more countercyclical monetary policy responses to global shocks; countries with more stringent regulation can ease policy more decisively despite higher global risk aversion (relevant for the COVID-19 juncture).
  - Macroprudential regulation does not materially affect monetary policy responses to capital flow shocks, which remain procyclical; additional tools may be needed to support monetary policy under extreme capital outflows.
- Data and methodological caveats:
  - Indexes of macroprudential regulation have measurement limitations; findings should be reexamined as data improve.
  - Future work should allow for dynamic effects and richer interactions with other policy tools (monetary policy, capital flow management, foreign exchange intervention).
- Suggested avenues for future research:
  - Optimal adjustment of macroprudential regulation given symmetric dampening effects.
  - Whether prompt adjustment of macroprudential measures (for example, easing when adverse shocks hit) can offset shocks.
  - Better characterization of transmission channels linking specific macroprudential measures to outcomes (credit growth stabilization, exchange rate stabilization, enabling countercyclical monetary policy).

### Meta-analysis on macroprudential effects on credit (brief)
- A meta-analysis (Araujo and others, forthcoming) of 58 empirical studies uses the regression:
  - ˆβj = θB MPMjB + θH MPMjH + θL MPMjL + γ Xj + εj . (3.1.1)
  - Dependent variable ˆβj is the standardized effect of tightening macroprudential policy on domestic credit growth (results j).
  - MPMjB, MPMjH, MPMjL are dummy variables for broad-based, housing, and liquidity/other measures; coefficients θ represent average effects on credit.
  - Xj includes control variables and a publication bias correction; estimation uses weighted-least-squares with weights proportional to estimate precision.
- Figure 3.1.1 (meta-regression results) reports average effects of macroprudential tightening on credit growth, differentiating emerging-market-only estimates and mixed-sample estimates; figure shows point estimates with 90 percent confidence intervals for Broad-based, Liquidity and other, and Housing measures.

*Source: IMF staff calculations and estimates, World Economic Outlook: The Great Lockdown, April 2020.*

### Box 3.1. Macroprudential Policies and Credit: A Meta-Analysis of the Empirical Findings

### Box 3.1. Macroprudential Policies and Credit: A Meta-Analysis of the Empirical Findings

### Main empirical finding from the meta-analysis
- Meta-analysis finds statistically significant effects of macroprudential tightening on credit, reducing it by 0.04 standard deviation, on average.
- A standardized effect of –0.04 corresponds to about a 0.6 percentage point reduction in year-over-year growth of real credit (measured at quarterly frequency), based on the average standard deviation of this variable (13 percent) in the sample.
- Magnitude of effects varies by macroprudential measure and country sample.
- Housing and liquidity-based measures appear to have larger average effects in emerging markets, although with wider confidence bands, reflecting substantial heterogeneity of individual estimates in this setting.
- Studies using microlevel data find stronger effects of macroprudential policies on credit than studies using aggregate data; this pattern also holds in emerging markets.

### Leakages and cross-border effects
- Meta-analysis evidence indicates macroprudential tightening tends to be associated with leakages, mainly through increases in cross-border or non-bank lending.
- This pattern is consistent with the hypothesis that international banks or other unconstrained institutions may fulfill domestic lending needs when local banks become constrained.
- A few studies suggest that, even after possible leakages are factored in, macroprudential tightening still tends to constrain credit growth (examples cited include Aiyar, Calomiris, and Wieladek 2014; Ahnert, Forbes, Friedrich, and Reinhardt 2018).

### Do emerging markets adjust macroprudential policy in response to global financial shocks?
- Regression specification used:
  ∆MPru_{i,t} = α_i + β · S_{i,t} + γ · C_{i,t} + ε_{i,t},
  where ∆MPru_{i,t} is the number of macroprudential net tightening actions in a given quarter; S_{i,t} includes US monetary policy shocks, the Chicago Board Options Exchange Volatility Index (VIX), and net capital outflows (instrumented as in the chapter); α_i are country fixed effects; C_{i,t} controls include expected inflation, the output gap, real credit growth, and commodity terms of trade, TOT_{i,t} (from Gruss and Kebhaj (2019)).
- Regression results show coefficients on shocks to US monetary policy, the VIX, and net capital outflows are all negative and statistically significant.
- Results are robust to excluding macroprudential measures targeted at foreign currency exposures.
- Interpretation: emerging markets tend to loosen macroprudential policies when global financial conditions tighten, and conversely tend to tighten regulation when global financial conditions ease.
- The same pattern has been observed during the COVID-19 pandemic, with most emerging markets easing macroprudential regulation as global risk aversion spikes and capital flows recede.

### Figure summary (Figure 3.2.1)
- The figure displays point estimates (negative) for US rate, Ln VIX, and Net outflows on the vertical axis labeled Macroprudential net tightening, with axis ticks from –0.35 to 0.00.
- Vertical lines correspond to 90 percent confidence intervals computed with Driscoll-Kraay standard errors.
- Note: VIX = Chicago Board Options Exchange Volatility Index.

### Research gaps and policy considerations
- More research is needed to determine whether the observed responses of macroprudential policy to global shocks are optimal.
- Further work should identify which other domestic and external factors should drive decisions to adjust macroprudential regulation.

*Authors of the box: Katharina Bergant, Francesco Grigoli, Niels-Jakob Hansen, and Damiano Sandri.*

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_Source: https://www.imf.org/-/media/files/publications/weo/2020/april/english/ch3.pdf_