The paradox of macroprudential policy and sovereign risk

This paper investigates the impact of macroprudential policy on sovereign risk. As long as macroprudential policy improves financial stability, it lowers sovereign risk and enables governments to increase spending without raising taxes. Consequently, countries with tighter macroprudential policies have lower primary budget balances and accumulate government debt over time. However, this effect diminishes or reverses when there is excessive regulation or high levels of debt. These findings are somewhat paradoxical: macroprudential policy may lower private debt, while increasing public debt.