Shocks Matter (original) (raw)
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Journal of International Money and Finance, 2019
This paper measures the e¤ect of monetary tightening in key advanced economies on net capital ‡ows around the world. Measuring this e¤ect is complicated by the fact that the domestic monetary policies of a¤ected economies respond endogenously to the foreign tightening shock. Using a structural VAR framework with quarterly panel data we estimate the impulse responses of domestic policy variables and net capital ‡ows to a foreign monetary tightening shock. We …nd that the endogenous response of domestic monetary policy depends on each economy's capital account openness and exchange rate regime. We use a method to compute counterfactual impulse responses for net capital out ‡ows under the assumption that the domestic policy rate does not respond to foreign monetary tightening. Our results suggests that failing to account for the endogenous response of domestic monetary policy biases down the estimated elasticity of net capital ‡ows to foreign interest rates by as much as one-third for countries with open capital accounts.
Macroprudential Policies as Buffer Against Volatile Cross-Border Capital Flows
The Singapore Economic Review, 2015
This paper investigates the effectiveness of macroprudential policies introduced by Turkey in late 2010. The unprecedented quantitative easing policies of advanced countries after the global financial crisis have presented serious financial stability concerns for most emerging countries including Turkey. To cope with these challenges, Turkey has devised new policy tools such as asymmetric interest rate corridor and reserve option mechanism. From the perspective of capital flows, the interest rate corridor works mainly through stabilizing supply of foreign funds, and the reserve option mechanism through decreasing the sensitivity of equilibrium exchange rate to shifts in the demand for foreign funds. Using a large panel of 46 countries and employing [Bruno and Shin (2013a). Capital flows, cross-border banking and Global liquidity. Working paper, Princeton university; Bruno and Shin (2013b). Assessing macroprudential policies: Case of Korea. Working paper, Princeton university] method...
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SSRN Electronic Journal, 2000
In the aftermath of the global financial crisis, a new policy paradigm has emerged in which old-fashioned policies such as capital controls and other government distortions have become part of the standard policy toolkit (the so-called macro-prudential policies). On the wave of this seemingly unanimous policy consensus, a new strand of theoretical literature contends that capital controls are welfare enhancing and can be justified rigorously because of secondbest considerations. Within the same theoretical framework adopted in this fast-growing literature, we show that a credible commitment to support the exchange rate in crisis times always welfare-dominates prudential capital controls as it can achieve the first best unconstrained allocation. In this benchmark economy, prudential capital controls are optimal only when the set of policy tools is restricted so that they are the only policy instrument available.
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SSRN Electronic Journal, 2020
BIS Working Papers are written by members of the Monetary and Economic Department of the Bank for International Settlements, and from time to time by other economists, and are published by the Bank. The papers are on subjects of topical interest and are technical in character. The views expressed in them are those of their authors and not necessarily the views of the BIS. This publication is available on the BIS website (www.bis.org).
Liquidity Shocks and Optimal Monetary and Exchange Rate Policies in a Small Open Economy?
2005
This paper studies the potential for liquidity crises and their impact on the course of monetary and exchange rate policies in a microfounded general equilibrium dynamic model in the tradition of Diamond and Dybvig (1983) and Chang and Velasco (2000). We produce a small open economy pure exchange overlapping generations model with random relocation along the lines of Smith (2002). The combination of random relocation and the assumed role of currency in interlocation trade creates random location - and country - speci…c liquidity needs. Banks naturally arise to provide much-desired insurance against these liquidity shocks. In this setting, if withdrawal demand for the bank's deposits is high enough, the bank will exhaust all its cash reserves and a liquidity shortage will occur. We provide a complete characterization of optimal interest rate policies in this setting. In a deterministic set up, we …nd that nominal interest rates that are desirable from a welfare perspective may a...
The effects of Monetary Policy on Capital Flows: A Meta-Analysis
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We investigate whether central banks are able to attract or redirect capital flows, by bringing together the entire empirical literature into the first quantitative meta-analysis on the subject. We dissect policy effects by the type of flow and by the origin of the monetary shock. Further, we assess whether policy effects depend on factors that drive investors to either search for yields or fly to safety. Our findings indicate a mean effect size of inflows in the amount of 0.09% of quarterly GDP in response to either a 100 basis point (bp) increase in the domestic policy rate or a 100bp reduction in the external rate. However, the effect size under a random effect specification is much lower (0.01%). Factors that significantly attract inflows include foreign exchange reserves, output growth, and financial openness, while factors that deter flows include foreign debt, capital controls, and departures from the uncovered interest rate parity. Also, both local and global risks matter (global risks exerting a larger pressure). Finally, we shed light on differences across the different types of flows: banking flows being the most responsive to monetary policy, while foreign direct investment being the least responsive.
Capital Control, Exchange Rate Regime, and Monetary Policy: Indeterminacy and Bifurcation
Dynamic Modeling and Econometrics in Economics and Finance, 2020
Will capital controls enhance macro economy stability? How will the results be influenced by the exchange rate regime and monetary policy reaction? Are the consequences of policy decisions involving capital controls easily predictable, or more complicated than may have been anticipated? We will answer the above questions by investigating the macroeconomic dynamics of a small open economy. In recent years, these matters have become particularly important to emerging market economies, which have often adopted capital controls. We especially investigate two dynamical characteristics: indeterminacy and bifurcation. Four cases are explored, based on different exchange rate regimes and monetary policy rules. With capital controls in place, we find that indeterminacy depends upon how inflation and output gap coordinate with each other in their feedback to interest rate setting in the Taylor rule. When forward-looking, both passive and positive monetary policy feedback can lead to indetermi...
Springer eBooks, 2006
We produce an example of a small open economy for which small increases in the world interest rate may induce a sharp decline in output and a precipitous depreciation of the nominal and the real exchange rate (RER). Due to a costly state veri¯cation (CSV) problem in domestic credit markets, combined with unrestricted international capital°ows, our economy generates two longrun equilibria, one with low GDP and a relatively depreciated RER, and one with high GDP and a relatively appreciated RER. The¯rst is always a saddle, while the second may be a sink or a source, depending on the level of the world interest rate. More precisely, there exists a critical level of the world interest rate above which the high-GDP steady state turns from a sink to a source. Hence unexpected increases in the world interest rate to \supercritical" levels may induce a \crisis" in the economy. This is identi¯ed in the model with the economy switching from an equilibriumpath approaching the high output steady state, to the saddlepath approaching the low output steady state. We simulate such a \crisis" trajectory for our model economy. In Mexico's recent history, periods of growth associated with an appreciation of the real exchange rate (RER) have alternated with periods of sharp contraction characterized by a depreciation of the RER. Our economy may display such behavior as an equilibrium response to changes in the world interest rate.