Sudden floods, macroprudential regulation and stability in an open economy

Pierre-Richard Agénor, Koray Alper and Luiz Awazu Pereira da Silva ()

Journal of International Money and Finance, 2014, vol. 48, issue PA, 68-100

Abstract: A dynamic stochastic model of a small open economy with a two-level banking intermediation structure, a risk-sensitive regulatory capital regime, and imperfect capital mobility is developed. Firms borrow from a domestic bank and the bank borrows on world capital markets, in both cases subject to a premium. A sudden flood in capital flows generates an expansion in credit and activity, as well as asset price pressures. Countercyclical capital regulation, in the form of a Basel III-type rule based on credit gaps, is effective at promoting macro stability (defined in terms of the volatility of a weighted average of inflation and output deviations) and financial stability (defined in terms of three measures based on asset prices, the credit-to-GDP ratio, and the ratio of bank foreign borrowing to GDP). However, because the gain in terms of reduced economic volatility exhibits diminishing returns, in practice a countercyclical regulatory capital rule may need to be supplemented by other, more targeted macroprudential instruments when shocks are large and persistent.

Keywords: Capital inflows; Open-economy DSSGE models; Macroprudential regulation; Macroeconomic stability; Financial stability (search for similar items in EconPapers)
JEL-codes: E44 E51 F41 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (36)

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Related works:
Working Paper: Sudden Floods, Macroprudential Regulation and Stability in an Open Economy (2015)
Working Paper: Sudden Floods, Macroprudential Regulation and Stability in an Open Economy (2014)
Working Paper: Sudden Floods, Macroprudential Regulation and Stability in an Open Economy (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:48:y:2014:i:pa:p:68-100

DOI: 10.1016/j.jimonfin.2014.07.007

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