Working Paper: CEPR ID: DP13951
Authors: Julien Bengui; Javier Bianchi
Abstract: The outreach of macroprudential policies is likely limited in practice by imperfect regulation enforcement, whether due to shadow banking, regulatory arbitrage, or other regulation circumvention schemes. We study how such concerns affect the design of optimal regulatory policy in a workhorse model in which pecuniary externalities call for macroprudential taxes on debt, but with the addition of a novel constraint that financial regulators lack the ability to enforce taxes on a subset of agents. While regulated agents reduce risk taking in response to debt taxes, unregulated agents react to the safer environment by taking on more risk. These leakages do undermine the effectiveness of macruprudential taxes, yet they do not necessarily call for weaker interventions. Quantitatively, we find that a well-designed macroprudential policy that accounts for leakages remains successful at mitigating the vulnerability to financial crises.
Keywords: macroprudential policy; capital flow management; regulatory arbitrage; financial crises; limited regulation enforcement
JEL Codes: F32; E58; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| macroprudential taxes (T) (F38) | reduced risk-taking by regulated agents (R) (G18) |
| macroprudential taxes (T) (F38) | increased risk-taking by unregulated agents (U) (D81) |
| reduced risk-taking by regulated agents (R) (G18) | increased risk-taking by unregulated agents (U) (D81) |
| macroprudential taxes (T) (F38) | financial stability (G28) |