Exchange Rates and Domestic Credit—Can Macroprudential Policy Reduce the Link?

Author/Editor:

Erlend Nier ; Thorvardur Tjoervi Olafsson ; Yuan Gao Rollinson

Publication Date:

September 11, 2020

Electronic Access:

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Disclaimer: 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.

Summary:

This paper examines empirically the role of macroprudential policy in addressing the effects of external shocks on financial stability. In a sample of 62 economies over the period of 2000: Q1–2016: Q4, our dynamic panel regressions show that an appreciation of the local exchange rate is associated with a subsequent increase in the domestic credit gap, while a prior tightening of macroprudential policies dampens this effect. These results are strong for small open economies, and robust when we explicitly account for potential simultaneity and reverse causality biases. We also examine a feedback effect where strong domestic credit pulls in additional cross-border funding, potentially further increasing systemic risk, and find that targeted capital controls can play a complementary role in alleviating this effect.

Series:

Working Paper No. 20/187

Frequency:

regular

English

Publication Date:

September 11, 2020

ISBN/ISSN:

9781513556550/1018-5941

Stock No:

WPIEA2020187

Format:

Paper

Pages:

52

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