Monetary policy spillovers and the role of prudential policies in the European Union

This paper explores how prudential policies can reduce the macro-financial spillover effects of foreign monetary policy on EU countries. Using local projection methods, I demonstrate that countries with stricter prudential policies experience smaller and less negative spillovers to bank credit and house prices following monetary policy tightening in the US, UK, and EA. Macroprudential measures, such as capital buffers, lending standards restrictions, and limits on credit growth, are particularly effective in mitigating spillovers from US monetary policy. In contrast, microprudential measures, including minimum capital requirements, risk weights, and limits on large exposures, work well in countering spillovers from UK monetary policy. The findings suggest that domestic prudential policies can help EU countries reduce their exposure to foreign monetary shocks. These policies may serve as valuable tools to manage spillovers from centre economies and within the EU.