Can Financial Hedging Serve Macroprudential Objectives?

Can financial hedging serve macroprudential objectives? We study this question in a small open economy with occasionally binding collateral constraints and stochastic commodity revenues. In the decentralized equilibrium, the government ignores how its borrowing and hedging choices affect collateral values, leading to overborrowing and insufficient hedging. The social planner internalizes this externality, hedges more aggressively, and implements the constrained efficient allocation with a tax on borrowing and a subsidy to hedging. Hedging improves welfare but weakens precautionary incentives. As a result, hedging and macroprudential policy are complements: greater insurance increases rather than reduces the need for prudential intervention. Calibrated to Mexico, the planner reduces the probability of Sudden Stops by two-thirds. Simple rules combining both instruments capture roughly 90% of the gains from optimal policy, and the optimal mix varies systematically with the correlation between commodity prices and tradable output.