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© 2023 International Monetary Fund
WP/23/12
IMF Working Paper
Strategy, Policy and Review Department
Macroprudential Policies in Response to External Financial Shocks
Prepared by Irineu de Carvalho Filho and DingXuan Ng*
Authorized for distribution by Stephan Danninger
January 2023
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
ABSTRACT: This paper examines how countries use Macroprudential Policies (MaPs) to respond to external shocks such as US monetary policy surprises or fluctuations in capital flows. Constructing a model of a small open economy with financial frictions and a MaP authority that adjusts loan to value (LTV) ratio limits on borrowers and capital adequacy ratio (CAR) limits on banks, we show that using MaPs where stochastic external financial shocks are present entails a trade-off between macro-financial volatility and GDP growth. The terms of the trade-off are a function of a few country characteristics that amplify financial channels of external monetary shocks. Estimating MaP reaction functions for a panel of 41 countries in the period 2000–2017, we find that countercyclical macroprudential policy in response to surprise US monetary tightening is more likely for countries with net short currency mismatches (that is, foreign currency denominated liabilities larger than foreign currency denominated assets), consistent with the model’s predictions. The paper also finds that domestic credit and interest rates are more insulated from US monetary tightening for countries that employ MaPs countercyclically.
| JEL Classification Numbers: | E60 |
| Keywords: | Macroprudential policy; external shocks |
| Author’s E-Mail Address: | idecarvalhofilho@imf.org, Ng_DingXuan@mas.gov.sg |
| JEL Classification Numbers: | E60 |
| Keywords: | Macroprudential policy; external shocks |
| Author’s E-Mail Address: | idecarvalhofilho@imf.org, Ng_DingXuan@mas.gov.sg |
Title Page
WORKING PAPERS
Macroprudential Policies in Response to External Financial Shocks
Prepared by Irineu de Carvalho Filho and DingXuan Ng1
Contents
1. Introduction
2. Model
3. Static Model
3 Model Simulations
4 Optimal Macroprudential Policy
6 Empirical Evidence
5 Results
6 Conclusions
Annexes
A. Model
B. Model Calibration
C. Proof of Proposition 1
D. Model Simulations
E. Empirical Annex
References
BOXES
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FIGURES
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TABLES
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We are grateful for the invaluable support and advice of Edward Robinson, as well as the comments of Adolfo Barajas, Heedon Kang, Erlend Nier, as well as seminar participants at the IMF and BIS. The views expressed in this paper are those of the authors and do not represent the position of the MAS or the International Monetary Fund. All remaining errors are ours.
Respectively, International Monetary Fund, and Monetary Authority of Singapore and National University of Singapore. E-mails: Irineu_De_Carvalho_Filho@mas.gov.sg, Ng_DingXuan@mas.gov.sg. This paper was written when Mr. de Carvalho Filho was on leave from the IMF, as Principal Economist at the Monetary Authority of Singapore. We are grateful for the invaluable support and advice of Edward Robinson, as well as the comments of Adolfo Barajas, Heedon Kang, Erlend Nier, as well as seminar participants at the IMF and BIS.The views expressed in this paper are those of the authors and do not represent the position of the MAS or the International Monetary Fund. All remaining errors are ours.