The Logic Of Macro Prudential Management Of Cross Border Capital Flows

After the international financial crisis, people began to reflect on the long term orthodox rational market theory system. They also had a negative impact on the unrestrained cross border capital flows.

Some financial macro prudential regulatory tools such as system importance addition and counter cyclical capital addition have also come into operation.

Referring to the regulation of cross-border capital flows, the popular explanation of the third generation method for currency crises is based on the "balance sheet effect" explanation: the influence of capital flow on a country's economy is amplified and strengthened by the market participants' behavior based on microcosmic rationality.

During the period of massive capital inflow, a large number of foreign debts began to accumulate, and the appreciation of local currencies and asset prices generally rose.

These factors reinforce each other.

But the problem is that such sustained large-scale capital flows may suddenly stop because of international political and economic factors.

The sudden stop of capital inflow will turn the former strengthening inflow mechanism into an accelerated outflow cycle.

In the course of the bursting of asset bubbles, domestic assets were sold at a low price in order to repay external debt and financial leverage.

The rapid sale of many will trigger the herd effect in the financial market, further enhance the pressure on the exchange rate of a country and the downward trend of domestic asset prices. The fall in the real effective exchange rate will further enhance the financial pressure caused by currency mismatch due to the currency of assets and liabilities of foreign currencies, and form the so-called balance sheet effect.

It may lead to debt default and financial crisis.

In the market, the micro body will capitals.

Acceptance is determined at a fixed price, and rational decisions are made.

However, the market price of capital will not be considered in the course of the formation of the market price, because of the concerted action of the market participants, such as the large amount of foreign loans borrowed during the boom period and the behavior of selling assets in a crisis.

It will not consider the low risk of capital risk based on systemic risk factors.

In other words,

The social cost of over financing is higher than the economic cost embodied in the market price.

These "rational" micro entities will overtake risks in the economic upturn and overly risk them in the economic downturn.

The micro entity does not and will not incorporate such negative externalities into its economic decision-making process, just like in a market without government intervention, enterprises will not spontaneously bring environmental pollution costs into their own economic decisions.

Excessive borrowing of foreign debt will pollute the financial market. The government needs to take macro prudential measures to mitigate the social consequences of such negative externalities.

In order to correct this negative externality, it is mainly managed by administrative examination and approval according to the current management mode; and macro Prudential Management emphasizes more on economic and price means, just like polluting taxes on polluting enterprises, pricing and trading carbon emissions, so as to avoid and reduce the distortion caused by administrative management.

Therefore, the difference between management concepts and methods in cross border capital flow management under the current foreign exchange management and macro Prudential framework is self-evident.

If foreign exchange management is to block all arbitrage links, we must adopt an exhaustive formula and make normative arrangements for all possible behaviors. In the light of macro Prudential logic, we should make more contributions to some general and prudent proportional management.

For example, the management of foreign exchange positions, the ratio of foreign exchange to deposit and loan, and the reserve requirement for foreign currency differences are also the category of macro prudence.

Actively studying the regulatory framework for cross-border capital flows under the macro Prudential framework, and reserving ports and spaces for the implementation of relevant policies in the information system construction, should be the consideration of foreign exchange management in promoting the reform at the macro Prudential level.