Capital Flows and Financial Stability: Monetary Policy and Macroprudential Responses
IMF Working Papers, August 1, 2011
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- Capital Flows and Financial Stability: Monetary Policy and Macroprudential Responses
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Bibliographic details
- Authors: Filiz D Unsal
- Published: August 1, 2011
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781462307272.001
Overview
- The resumption of capital flows to emerging market economies since mid 2009 posed two interrelated challenges:
- (i) to prevent capital flows from exacerbating overheating pressures and consequent inflation, and
- (ii) to minimize the risk that prolonged periods of easy financing conditions will undermine financial stability.
- Conventional monetary policy retains its role in counteracting overheating and inflation, but there are doubts it is sufficient to guard against financial instability.
- Increased calls for the development of macroprudential measures with an explicit focus on systemwide financial risks motivate the analysis.
Model and approach
- Analysis conducted in an open economy DSGE model with nominal and real frictions.
- Focus on the interplay between monetary policy and macroprudential regulations.
Key findings
- Macroprudential measures can usefully complement monetary policy.
- Even under the "optimal policy," which calls for a rather aggressive monetary policy reaction to inflation, introducing macroprudential measures is found to be welfare improving.
- Broad macroprudential measures are more effective than measures that discriminate against foreign liabilities (prudential capital controls).
- Macroprudential measures are not a substitute for an appropriate monetary policy reaction.
- Macroprudential measures are less useful in helping economic stability under a technology shock.
Policy implications and recommendations
- Continue to use conventional monetary policy to counteract overheating pressures and inflation.
- Introduce broad macroprudential measures to complement monetary policy and improve welfare outcomes.
- Avoid relying solely on prudential capital controls that discriminate against foreign liabilities; prefer broader macroprudential instruments.
- Recognize the limited efficacy of macroprudential measures in the face of technology shocks; ensure monetary policy remains appropriately responsive.
Content in this bundle
- _wp11189 — Introduction and Model