| Abstract: |
Using a model of strategic interactions between two countries, I investigate
the gains to international coordination of financial regulation policies, and
how these gains depend on global lending conditions. When global lending
conditions are determined non-cooperatively, I show that coordinating
regulatory policies leads to a Pareto improvement relative to the case of no
cooperation. In the non-cooperative equilibrium, one region - the core -
determines global lending conditions, leaving the other region - the periphery
- in a sub-optimal situation. The periphery then tightens regulatory policy to
reduce the cost of sub-optimal lending conditions. Yet, in doing so, it fails
to internalise a cross-border externality: tightening regulatory policy in one
region limits ex ante borrowing in the other region, which increases the cost
of sub-optimal lending conditions for the periphery. The equilibrium with
cooperative regulatory policies can then improve on this outcome as both
regions take into account the cross-border externality and allow for larger ex
ante borrowing, ending in a lower cost of suboptimal lending conditions for
the periphery. |