Think Global, Act local
Speech given by
Minouche Shafik, Deputy Governor, Markets and Banking
Joint Bank of England, IMF and Hong Kong Monetary Authority conference on Monetary,
Financial and Prudential Policy Interactions in the Post-Crisis World, Hong Kong
24 October 2016
I would like to thank James Benford, Ambrogio Cesa-Bianchi, Fernando Eguren Martin, Julia Giese,
Sujit Kapadia, Grellan McGrath, Michael McLeay, Dennis Reinhardt, and Simon Whitaker for their
assistance in preparing these remarks. I am grateful to other Bank colleagues for useful comments on
an earlier draft.
1
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Introduction
The benefits of open capital markets are clear. They facilitate the flow of finance to where it would be most
productive and help ensure global resources are allocated most efficiently. They allow savers and investors
to diversify portfolios beyond national borders, and they provide a greater range of funding sources to fast
growing economies and businesses. Motivated by these gains from openness, greater capital mobility has
been one of the defining features of the global economy since the end of the Bretton Woods era, as first
advanced and then emerging market economies liberalised their capital accounts (Chart 1).
However, open capital markets also come with risks. Breaking the link between domestic saving and
domestic investment allowed countries to accumulate ever larger stocks of external assets and liabilities.
And that has contributed to another defining feature of the global economy since the breakdown of
Bretton Woods: a significantly greater frequency of crises.
Keynes warned when he said: "The whereabouts of the better 'ole' will shift
Of course this is no more than
with the speed of the magic carpet. Loose funds may sweep around the world, disorganising all steady
business."1 And for him the prescription was clear: "the movement of capital
funds must be regulated; - which
in itself will involve far-reaching departures from laissez-faire arrangements." So must we return to a world of
capital controls in order to break the cycle of boom and bust?
Thankfully, the choice is not as stark as that. As set out in a recent joint report by the IMF, FSB and BIS
which was commissioned by the Chinese G20 presidency,2 macroprudential tools offer us a way of reducing
risks from rapid credit growth or building resilience of the financial system that should lower the frequency of
financial busts, and reduce the risk that a downturn becomes a crisis. This means that we do not need to
choose between openness and stability.
In the first part of this speech I would like to use some research being undertaken in the Bank of England to
- -
show how the existence of macroprudential tools specifically a countercyclical capital buffer can reduce
the frequency of crises, and improve the available set of outcomes. Perhaps more relevant, given the theme
of this conference is international ramifications of domestic policies, this research suggests that reciprocity
of those policies can further reduce the likelihood of a crisis by more than if countries act alone.
Of course the countercyclical capital buffer is just one tool, and its application is limited to banks. So I would
like to use the second part of this speech to talk about the financial stability implications of the growth in
market based finance in recent years. This growth is welcome, not least because it reduces the reliance of
both savers and borrowers on the banking system. But it is not without risks, partly because macroprudential
policy for market-based finance is less well developed than that for banks. I will argue that those risks can be
1
(2012); for 'ole read hole, a handy place to hide one's money (Grote and Marauhn
As quoted in Bush 2006).
2
IMF-FSB-BIS (2016).
2
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reduced by the development of strong institutions and deep domestic capital markets by the recipients of
global capital flows, and by measures to reduce the risk of sudden stops such as those recently proposed by
the FSB to address structural vulnerabilities from asset management activities.
There are two themes that recur throughout these remarks. The first is that although cross-border bank flows
have plateaued, in many other ways the global financial system is as interconnected as ever, and that we
need to be mindful of spillovers from elsewhere when setting policy. The second is that by acting in their
domestic best interest, policymakers can often improve the global outcome. In short, we need to think
globally, act locally.
The need to think globally
with some context. Evidence of a 'global financial cycle', which drives
Let me start co-movements in asset
prices, and pro-cyclical gross capital flows, has been well documented, for example by Helene Rey (2013)
and by my colleague Kristin Forbes (2016). Global financial markets have become more correlated and
common shocks play an important role. According to the IMF, around three-quarters of equity and foreign
exchange returns in both advanced and emerging market economies are now attributable to international
factors.3
We have also observed an increase in the co-movement of domestic credit growth across countries over the
last two decades (Chart 2). Elevated domestic credit growth has been found to be the best single predictor
of banking crises (Drehmann et al (2011), Schularick and Taylor, 2012). However, banking crises come
"in waves" (Reinhart and Rogoff, 2009; Laeven and Valencia, 2013), which, together with signs of greater
correlation of credit growth across countries, suggests a role for external determinants and/or direct
contagion.
There is research underway at the Bank of England which studies the effect of credit growth abroad on
financial stability at home, in particular, on the probability of experiencing a banking crisis4. It finds that even
when domestic credit growth is moderate, elevated credit growth abroad could result in financial instability at
home for example by boosting cross-border lending, through spillovers into domestic asset prices or by
creating the potential for contagion in the event of a banking crisis abroad.5
In terms of magnitudes, a one standard deviation in foreign credit growth over five years increases the
probability of a domestic banking crisis by around 2 percentage points6 - a relatively large number given the
3
IMF (2016).
4
Cesa-Bianchi et al. (forthcoming).
5
In this research, domestic credit growth is defined as credit extended by domestic banks to the private non-financial sector in a given
country. Foreign credit growth is defined as the average of the growth in credit extended by domestic banks to the domestic private
nonfinancial sector in all other countries.
6
On the basis of modelling and assumptions set out in Technical Appendix 1: Foreign credit growth and domestic financial stability.
3
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overall frequency of these crises is about 3%7. This is very similar to the estimated impact of domestic credit
growth, suggesting that foreign credit growth could even be as important as domestic credit growth in
explaining movements in each country's risk of
a banking crisis. The research also finds that the effect of
foreign credit growth on domestic financial stability is stronger for countries that are more financially open.
Taking all of this together underlines the need to think globally. At first blush, this may appear to sit
awkwardly with the largely domestic nature of macroprudential tools that have been developed thus far. But
there are number of ways in which international considerations form part of the calibration of those tools.
-
Acting locally the use of domestic macroprudential tools to mitigate risks from abroad
The most obvious way to take international considerations into account is by treating risks emanating from
abroad as an important input when setting domestic macroprudential policy. At the Bank of England, for
example, spillovers from the crystallisation of global risks play a key part of the design of the Bank of
England's annual stress tests, which are used to inform the Financial Policy Committee's (FPC) decision on
the countercyclical capital buffer.8 By building resilience to stress, the countercyclical capital buffer allows the
banking system to remain an absorber, rather than an amplifier, of shocks, and reduces the probability of a
downturn abroad becoming crisis at home.9
However, we cannot go it alone. There is mounting evidence that the effectiveness of macroprudential
policies may be affected by leakages across borders. For example, Cerutti et al (2015) and Reinhardt and
Sowerbutts (2015) provide evidence that cross-border borrowing may increase after domestic
macroprudential policy is tightened. And Berrospide et al (2016) similarly find that domestic prudential policy
may be less effective when banks operate globally.
All of which points to the benefits of reciprocity, which I would like to illustrate using some results that
develop another strand of Bank research10. Consider a stylised two-country model in which each of the two
countries' domestic credit is provided partly by banks from the other. Each country has a macroprudential
- -
tool a countercyclical capital buffer at its disposal, which can reduce the probability of a crisis, albeit at
the cost of lower output in the short run. The presence of leakages worsens this tradeoff between short term
output and stability.
7
Based on data from 38 advanced and emerging economies over the period 1970 to 2011, as set out in Cesa-Bianchi et al
(forthcoming).
8
The 2016 stress test scenario, results of which will be published in 2016Q4, embodies a synchronised severe downturn in global
output, which sees global growth trough at -1.9% as it did in 2008.
9
In March 2016, the FPC raised the countercyclical capital buffer rate to 0.5%, consistent with its view that financial conditions had
phase, and the Committee's intention to move gradually toward a buffer rate in the region of 1% in a
moved out of the post-crisis
standard risk environment. Following the result of the EU referendum, this rate was reduced to 0% in order to reduce regulatory capital
buffers and increase banks' capacity for lending as the real economy goes through a period of adjustment.
10
Aikman et al (forthcoming).
4
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Under a reasonable calibration11, a 15pp increase in credit growth in both countries over three years would
increase the probability of a crisis by more than 6pp, as shown by the dark blue bars in Chart 3. Were there a
reciprocity agreement between the two countries - by which an increase in the countercyclical buffer in one
country is applied to lending in that economy by banks in the other country - they would both increase the
countercyclical buffer by around 1pp, bringing the probability of a crisis down to only 1.8pp higher than
before the shock - as shown in the yellow bars.
However, if there were no reciprocity, any tightening of the countercyclical buffer will be partly offset by
leakages. The higher buffer would boost resilience by less since foreign lenders in each country would be
unaffected, reducing its overall effect on the crisis probability. This is shown in the light blue bars, in which
the probability of a crisis is 0.5pp higher than with reciprocity, despite policymakers choosing to increase the
countercyclical buffer a little more.
This feature of reciprocity - that it allows both countries to reduce the probability of a crisis by more than if
- can be thought of as "enlightened self interest."12
they were acting alone And it is one of the reasons why it
was built into the international framework for the countercyclical capital buffer. As part of the Basel III
framework, reciprocity is mandatory for all Basel Committee member jurisdictions, and the BIS maintains a
website where information on countercyclical capital buffer decisions of all participating countries is captured
and which banks can use to calculate their institution-specific requirements. And reciprocity of the
countercyclical capital buffer is a legal requirement in the European Union under CRD IV.13
Reciprocity also helps address the old problem of asymmetric adjustment of global imbalances. Suppose a
deficit country wishes to contain the supply of credit and build resilience in its financial system by raising the
buffer. If a surplus country whose banks are lending to the deficit country reciprocates, its banks should be
incentivised to lend less to the deficit economy, and more to their domestic economy. That should increase
domestic demand in the surplus country, and hence demand for deficit country exports, reducing the overall
level of imbalances.
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All of this leads me to conclude that macroprudential policies as currently designed can be used to
mitigate risks from abroad. By building domestic resilience, the countercyclical capital buffer can ensure
spillovers from abroad are not amplified. The use of existing agreements around reciprocity can improve the
available set of outcomes for everyone and can also help reduce imbalances in capital flows. Moreover,
given the tendency for global credit growth to affect the probability of domestic crises, any macroprudential
policy which tames the financial cycle in one country will have positive externalities for the world.
11
Details of the modelling and assumptions used are set out in Technical Appendix 3: Model of international policy reciprocity.
12
As coined by IMF-FSB-BIS (2016).
13
In both cases, if an authority sets a countercyclical buffer greater than 2.5% of risk weighted assets, reciprocity becomes
discretionary.
5
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The changing nature of global capital flows
However, the focus of existing macroprudential tools on banks and banking flows means their ability to
mitigate risks from abroad has its limitations. This is particularly true given the changing composition of
global capital flows.
While cross-border banking flows have declined, international marketable debt flows have increased (Charts
4 and 5). This has been associated with the expansion of asset management: as at the end of 2015, the total
assets under management of the top 100 asset managers exceeded $50trn. At the same time, there has
been a shift of capital flows away from advanced economies to emerging markets. Whereas these
economies received less than 10% of cross border flows before the crisis, they have received 25% of those
flows since 2009.
The growth of market-based finance and asset management is creating new sources of funding, adding
welcome diversity to the financial system, particularly for emerging markets. And in some ways these flows
-
are less risky for example the average maturity of international securities issued by emerging markets is 10
years, reducing rollover risk and exposure to a sudden flight of capital.
But market-based flows have risks nonetheless. As Chart 6 shows, portfolio flows to emerging markets have
been just as volatile as bank flows once their relative sizes have been taken into account.14 And Hoggarth et
al (forthcoming) find that portfolio debt flows to emerging markets in particular are pro-cyclical, in that they
rise when global volatility is low and reverse when global volatility increases, especially when denominated in
foreign currencies. So as these gain in importance relative to bank flows emerging markets could have
greater volatility inflicted on them by global factors.
As well as the type of instrument, risk also depends on who is purchasing those instruments. Mutual fund
purchases of debt and equity have become an important source of finance for emerging markets. Since
end-2009, mutual funds accounted for on average 5% of non-bank portfolio debt flows to advanced
economies but more than one-fifth of those to emerging markets. And mutual fund flows to emerging markets
seem particularly prone to abrupt stops (Chart 7).
Intuitively, market-based finance makes domestic bank-focussed macroprudential policies less effective.
Raising the countercyclical capital buffer for banks does little to reduce risks from, or build resilience in, the
provision-of market based finance. Moreover, it can induce regulatory leakage as credit migrates to the
market-based finance sector.
14
-
The measure of volatility used is the standard deviation of flows relative to the long-term mean of the respective flows the coefficient
of variation. This controls for the relatively smaller role that portfolio flows have historically played in emerging market financing relative
to bank flows.
6
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Chart 8, which is based on a similar illustrative model and calibration to the one I discussed earlier,
demonstrates this point15. It shows the tradeoff available to a domestic policymaker whose only tool, the
countercyclical capital buffer, is bank-focussed. In the scenario where all credit is the economy is provided by
banks (the blue line), the policymaker can use this tool in response to a 15pp increase in credit growth in the
domestic economy over three years to reduce the probability of a crisis to well below 1% before the cost (in
the form of lost output) becomes material. However, if 25% of credit in the economy is provided by
market-based finance (red line), the policymaker struggles to reduce the probability of a crisis significantly
below 2.5% as tightening the countercyclical capital buffer does not reduce the provision of market-based
finance.
Acting locally to address the risks of market-based finance
So how can we address risks emanating from global, market based finance? This is the subject of several
panel discussions over the course of this conference, and indeed major international workstreams including
of the FSB. So rather than pretend to have the answers, I will limit myself to two simple observations about
how policymakers acting in their own best interest can help reduce these risks.
The first is that by building strong domestic institutional frameworks and deepening domestic capital markets,
recipients of global flows can reduce their susceptibility to volatility in those flows. Central bank credibility, a
robust macroprudential framework, and fiscal stability all reduce the risk of a sudden stop, and liquid
domestic capital markets make it easier to absorb larger inflows. As such they are prerequisites to being able
to enjoy the benefits of open capital markets sustainably.
The second observation is that by encouraging the use of responsible liquidity management, source
countries can reduce the probability of a sudden rush for the exit. The FSB's recent
proposals to reduce
structural vulnerabilities from asset managers are an excellent example of this. Recommendations to
enhance reporting to authorities, undertake more stress testing and to extend the suite of liquidity
will all help better align investors' expectations of liquidity with
management tools available to fund managers
reality, and hence ensure their flows to the rest of the world are less flighty and more sustainable.
Conclusion
Thus far I have focussed on the idea that acting in our own local interest to build up domestic resilience helps
protect us from global forces that we cannot control on our own. Let me end with a word on the benefits and
limitations of working together.
15
Details of the modelling and assumptions used are set out in Technical Appendix 2: Model of monetary-macroprudential policy
coordination with market-based finance.
7
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There are many ways in which co-operation on macro-prudential policies could be deepened further. Options
which could warrant further investigation range from formalising the exchange of information, to frameworks
for reciprocity for tools beyond the countercyclical capital buffer, to common stress test scenarios and risk
assessment that are used across the world. And were we to further integrate the consideration of the
international financial cycle into the setting of domestic macroprudential policies, it would likely improve the
available set of outcomes further still.
However, the body of evidence required to justify including the interests of other nations in the setting of
domestic policy is understandably large, even when the long run benefits would be to all. This is more true
now than ever, as the unequal distribution of benefits from globalisation has increased scepticism about
international co-operation. The analysis I have outlined today shows that even without consensus around a
fully articulated global framework for macroprudential policy, we can make quite a bit of progress by
countries pursuing their local national interests.
8
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TECHNICAL APPENDICES
1. Foreign credit growth and domestic financial stability
Eguren Martin and Thwaites (forthcoming) explore the effect of 'foreign' credit growth (that is,
Cesa-Bianchi,
domestic credit growth in the rest of world) on domestic financial stability. In particular, they look at the effect
of foreign credit growth on the probability of experiencing a banking crisis at home. In order to do so, they
extend the baseline regression in Schularick and Taylor (2012), which only looks at the effect of domestic
credit growth, by also considering its foreign counterpart. Therefore, their baseline regression is as follows:
5 5
∗
= α + ∑ + ∑ + +
Bririri,s α1,i∆Brddi,s-i α2,i∆Brddi,s-i εi ri,s
i=1 i=1
Where is a dummy variable that takes the value of one if a banking crisis occurs at time r in country
Bririri,s
∆Brdd
i, is the percentage growth of credit from domestic banks to the domestic private non-financial sector
∗
∑
and ∆Brdd∗ is its foreign counterpart, constructed as = , with weights determined
∆Brddi,s i≠iψi∆Brddi,s ψi
by PPP-GDP levels. is a country fixed-effect.
εi
This specification is estimated via OLS using a panel data of 38 advanced and emerging countries for
1970-2011. Banking crises data comes from Laeven and Valencia (2013), while credit data comes from the
BIS. The resulting estimated coefficients can be found in the table below.
In order to quantify the average effect of foreign credit growth on the probability of experiencing a domestic
banking crisis, the coefficient attached to the sum of lags of foreign credit growth (1.42) is multiplied by a one
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∗
standard deviation in the five-year average16 of (1.6%). The resulting figure (0.022) means that a
∆Brddi,s
one standard deviation in foreign credit growth over five years increases the probability of experiencing a
domestic banking crisis by 2.2 p.p. In order to put this number in perspective, it is useful to note that the
domestic analogue of this figure is 1.6 p.p., and that the overall frequency of crises in the sample is only 3%.
2. Model of monetary and macroprudential policy coordination with market-based finance
Aikman, Giese, Kapadia and McLeay (forthcoming) use a calibrated two-period New Keynesian framework to
examine the trade-offs and interactions between macroprudential and monetary policies. Their model
includes the possibility that rapid credit growth in the first period leads to a future financial crisis, and
analyses the decision facing a policymaker with access to both a macroprudential tool, a countercyclical
capital buffer (CCyB), and a traditional monetary policy tool, the policy interest rate. In the variant of the
model used for the results shown in Chart 8, some credit is provided by a market-based finance sector,
which reduces the effectiveness of macroprudential policy.
M
B,
This model is described by the following set of equations, where all variables except B1 B1 (growth rates),
M
B, and (probabilities) are expressed as deviations from steady state.
α1 α1 α1
1) = - - + IS curve
x1 E1 PSx2 σ(i1 E1 PSπ2 ψr1)
= + +
2) Phillips curve
π1 κx1 E1 PSπ2 νr1
=
3) r1 ψk1 Banking sector credit spreads
B B
= + + +
4) B1 φ0 φii1 φs Br1 ν1 Banking sector real credit growth
M M
5) = + + + Market based sector real credit growth
B1 φ0 φii1 φs Mr1 ν1
B B
= (1 + + +
6) Banking sector crisis probability
α1 (dxp(h0 hBB1 hik1))-1)-1
M
= (1 + + M))-1)-1
7) (dxp(h0 Market-based sector crisis probability
α1 hBB1
B M
8) = + (1 - Total crisis probability
α1 bα1 b)α1
The IS and Phillips curves determine, respectively, output and inflation as functions of current and
(x1) (π1),
expected future output and inflation17 and the policy interest rate (i1). Output and inflation also depend on
banking sector credit spreads (r1). Spreads push down on aggregate demand in the IS curve by increasing
the interest facing borrowers in the economy. They also have a negative near-term effect on aggregate
supply, raising inflation for a given level of output via an endogenous cost-push mechanism in the Phillips
Curve. Such a short-term supply cost could come about if higher spreads affect the relative price of different
factors of production, for example by increasing the cost of capital and depressing investment.
16
We rely on five-year averages given we look at the sum of coefficients of five lags of ∆Cred*
17
Following Ajello et al (2016), private sector agents' expectations of period 2, denoted by
E1 PS, depart from full-information rational
expectations, which would lead them to cut back spending when credit was growing quickly and a crisis became more likely. Their
expectations instead treat the crisis probability as fixed and negligibly small. See Ajello et al (2016) for more details.
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Credit spreads are affected by the setting of the CCyB when banks are required to use a greater
(k1):
proportion of more expensive equity, this raises their weighted average cost of funding, leading them to
increase the spread between lending rates and the policy rate. The benefit of using the CCyB is that it
via two channels: first, activating the CCyB can 'lean'
reduces the probability of a banking sector crisis (α1 B)18
B
< 0 >
against a build-up in banking sector credit growth B), since and 0); and second, for a given
(B1 (φs hB
level of credit growth, a higher CCyB directly reduces the probability of a crisis due to the resilience benefits
<
of higher bank equity capital 0). Higher interest rates can also reduce the probability of a banking
(hi
<
sector crisis through the same leaning channel (φi 0), but do not increase resilience directly.
-
The banking sector only provides a proportion (b) of credit to the economy, the remaining (1 b) share is
provided by the market based finance sector M). While higher interest rates have the same effect in
(B1
reducing credit and the crisis probability in both sectors, increasing the CCyB leads to a leakage of credit
from the banking sector to the market based sector, so the marginal effect of a higher CCyB on market-
M
based finance is to increase its growth rate > 0). This increases the probability of a crisis originating in
(φs
the market based finance sector M). In addition, there is no resilience benefit from a higher CCyB working
(α1
to reduce the probability of crises originating in the market-based finance sector. The overall probability of a
financial crisis is equal to the sum of the probabilities in each sector, weighted by their market-share. Both
sectors are subject to shocks B, M).
(ν1 ν1
A single policymaker sets both instruments, the CCyB and the interest rate, to minimise the joint loss function
given below under discretion.
1
2
L = + 2) + (1 - + +
9) Loss function
(π1 κx1 α1)αE1L2,MB α1(1 ε)αE1L2,B
2
In period 1 the policymaker seeks to minimise the traditional monetary policy goals of avoiding deviations in
κ
inflation and output from their targets, with a relative weight of placed on the output goal. In period 2, loss is
exogenously greater in crisis states (L2,B) than in non-crisis states (L2,MB). This gives the policymaker an
endogenous financial stability objective of trying to minimise The policymaker also places an additional,
α1.
ε
exogenous weight on financial stability.19
The authors calibrate the model largely using a range of empirical estimates for the UK from various models
developed by Bank of England researchers. Importantly, the calibration interprets each time period as three
years, longer than most business cycle models, where each period is typically one quarter or one year.
18
The equations determining the crisis probability are given logistic formulations to ensure that the probability is between 0 and 1.
19
This aims to capture many real-world central bank financial stability mandates, which arguably place additional weight on avoiding
very costly outcomes such as financial crises, over and above quadratic inflation and output losses present in typical monetary policy
loss functions. This could be motivated via a desire by taxpayers to avoid bearing the bailout costs of future systemic crises, or a desire
to avoid other distributional effects of crises. It could also be justified if there is a desire to avoid worst-case outcomes and the costs of
crises are uncertain.
11
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The longer timeframe better captures the prolonged build-ups in credit that precede financial crises in the
data, as well as the longer implementation lags involved in setting macroprudential policy.
κ =
Chart 8 uses the baseline calibration from Aikman et al (forthcoming), which sets 1, larger than usual in
σ =
the literature given the longer timeframe, and sets 0.6.20 A 1pp tightening in the CCyB increases spreads
= = 1)
by 20 basis points (ψ 0.2), while higher spreads have a larger effect on demand (ψ than supply
= 0.4),
(ν so all else equal inflation falls when the CCyB is tightened. Absent policy, 3 year cumulative real
credit growth is assumed to equal its recent UK average of 21% = 0.21), which can be reduced by higher
(φ0
= =
interest rates -1.5) or credit spreads -6). The trade-off curves in Chart 8 are derived under the
(φi (φs
B B
= =
assumption that there is a 5pp per year positive credit shock for 3 years, (ν1 ν1 0.15). With no policy
response, such a shock would increase the crisis probability by 2.75pp. Because the shock is purely
domestic, this is smaller than the effect of the global shock examined in Chart 3.
The crisis probability equation is estimated directly on a cross-country historical dataset, similar to the one
described in appendix 1, giving estimates of = -1.7, = 5.2, = -27.8. The intercept is then adjusted
h0 hB hi
= -1.7 +
to h0 0.11hi, to incorporate a steady state capital to risk-weighted asset ratio of 11%. The leakage
1
φsM(1-b)
-
of credit into the market-based finance sector, given by ( ) is equal to in the red line in Chart 8, to
3
φsBb
make it the same size as the leakage to foreign banks in the alternative model discussed below. Therefore
M
b = 0.75 implies that = 1. Finally, the policymaker's preference parameter is set to κ = 0.05, broadly
φs
ε
consistent with the literature where loss is derived from the welfare of agents in the economy, α=0.99 and
is varied to derive each curve in Chart 8, where each point represents optimal policy for a different ε. The
period 2 loss if there is a
policymaker's crisis, relative to when there is not, is set to just over 4% of GDP lost
for 3 years. This is broadly consistent with Chart 6 in Brooke et al (2015), which assumes that the cost of
crises will be lower under a credible resolution regime.
3. Model of international policy reciprocity
Extending Aikman et al (forthcoming), the results in Chart 3 are from a new model that builds on their paper
by adding a second country to their model and by examining international policy leakages and coordination.
=
For simplicity, the model assumes that there is no market-based finance sector (b 1). In its place, the
model allows for an additional determinants of the crisis probability. Domestic credit growth (B1) still predicts
domestic crises but the credit measure is split b