Regulatory Arbitrage and Economic Stability

This paper shows that national bank regulation can ensure nancial and economy stability only if business cycles are driven by domestic and non- nancial global shocks. If global nancial shocks are more important, by contrast, national regulatory policies can be destabilizing. These inferences are drawn from a two-country DSGE model with global banking, nancial regulation and the nancial accelerator mechanism. The results indicate that bank regulation suppresses the ampli cation e¤ects of the nancial accelerator mechanism when countries face domestic and non- nancial global shocks. When there is a global nancial shock, however, highly-regulated countries are more vulnerable to the ebbs and ows of global bank lending since their rms are more leveraged and externally funded. More generally, the results imply that the nancial trilemma is not binding in economies where domestic and non- nancial global shocks drive the business cycle.