Informality, Frictions, and Macroprudential Policy

IMF Working Papers, November 27, 2019

Source details

The paper analyzes the effects of macroprudential policies using an estimated dynamic stochastic general equilibrium (DSGE) model tailored to developing markets.
Informality is explicitly introduced in the labor and goods markets within a small open economy framework that includes financial frictions, nominal and real rigidities, labor search and matching, and an explicit banking sector.
The estimated model is used to run welfare analysis under optimized monetary and macroprudential rules.
Main headline result: informality reduces the efficiency of macroprudential policies following a convex fashion, but combining macroprudential policy with an inflation targeting objective could be beneficial.

Framework: estimated DSGE model for a small open economy.
Key model features:
- Explicit informality in labor and goods markets.
- Financial frictions.
- Nominal and real rigidities.
- Labor search and matching.
- Explicit banking sector.
Analysis approach: welfare analysis under optimized monetary and macroprudential rules using the estimated model.

Informality lowers the effectiveness of macroprudential policy.
The reduction in efficiency caused by informality follows a convex relationship.
Joint policy design (macroprudential policy combined with an inflation targeting objective) can yield beneficial outcomes relative to macroprudential policy alone.

Design macroprudential policy acknowledging the presence and quantitative effects of informality in labor and goods markets.
Consider combining macroprudential tools with an inflation targeting objective to improve welfare outcomes.
Optimize monetary and macroprudential rules jointly rather than in isolation to account for interactions driven by informality and financial frictions.

Informality, Frictions, and Macroprudential Policy, Moez Ben Hassine and Nooman Rebei, IMF Working Papers, November 27, 2019.