Spillovers at the Extremes: The Macroprudential Stance and Vulnerability to the Global Financial Cycle

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Prior evidence suggests that macroprudential policy has small and insignificant effects on the volume of portfolio flows. We show, however, that these small effects mask very different relationships across the global financial cycle. A tighter ex ante macroprudential stance can amplify the impact of global risk shocks on bond and equity flows—increasing outflows by significantly more during risk-off episodes and increasing inflows significantly more during risk-on episodes. These effects are small and often insignificant around the risk distribution mean (and much smaller than the direct effect of risk-on/risk-off shocks), but larger at the extremes, especially for extreme risk-off periods. These amplification effects can occur even if macroprudential regulations moderate the impact of the global financial cycle on banks, because the regulations shift risks in ways that aggravate vulnerabilities in other parts of the financial system. This paper estimates these relationships using a policy-shocks approach that corrects for reverse causality by combining high-frequency risk measures with weekly data on portfolio investment and a new measure capturing the intensity of macroprudential stances. Overall, the results support a growing body of evidence that macroprudential regulation can reduce the volume and volatility of bank flows but increase vulnerabilities through portfolio investors, especially during extreme risk shocks.