Financial Stress in Emerging Markets: The Tail-Risk Trade-Offs Between Growth and Financial Stability Policies

We apply panel quantile regressions within a growth-at-risk framework to examine how macroprudential policies and capital controls shape the transmission of domestic financial stress and global financial volatility on future economic growth in 25 emerging market economies from 1996Q1 to 2022Q4. Our findings reveal strongly state-dependent and horizon-specific policy effects. Macroprudential policies appear more strongly associated with limiting downside risks over short horizons, particularly in periods of elevated financial stress. Tighter macroprudential regimes are also associated with economically meaningful reductions in upper-tail growth outcomes, suggesting that these tools operate pre-emptively by restraining the build-up of financial vulnerabilities before severe stress materialises. In contrast, capital controls exhibit weaker direct effects on growth but appear more closely associated with mitigating the medium-term transmission of financial stress. While short-run policy adjustments yield limited evidence that policy regimes insulate EMEs from domestic financial stress or global financial volatility, more persistent capital control regimes are associated with a weaker transmission of financial stress to future growth at medium-term horizons. Overall, the results suggest that macroprudential and capital flow management tools operate through distinct but complementary roles in managing downside risks in emerging markets.