Macroprudential Policies in Response to External Financial Shocks
IMF Working Papers, January 20, 2023
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Bibliographic details
- Authors: Irineu E de Carvalho Filho, DingXuan Ng
- Published: January 20, 2023
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9798400230035.001
Summary and scope
- Examines how countries use Macroprudential Policies (MaPs) to respond to external shocks such as US monetary policy surprises or fluctuations in capital flows.
- Constructs 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.
- Empirical analysis: estimates MaP reaction functions for a panel of 41 countries in the period 2000–2017.
- Publication details: Pages: 46; Volume: 2023; Issue: 012; Series: Working Paper No. 2023/012; DOI: https://doi.org/10.5089/9798400230035.001; Stock No: WPIEA2023012; ISBN: 9798400230035; ISSN: 1018-5941.
- Authors and date: By Irineu E de Carvalho Filho, DingXuan Ng; January 20, 2023.
Theoretical framework and mechanisms
- Model features:
- Small open economy.
- Financial frictions.
- A MaP authority that adjusts LTV ratio limits on borrowers and CAR limits on banks.
- Key model result:
- 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.
Empirical findings
- Sample and period:
- Panel of 41 countries.
- Period: 2000–2017.
- Main empirical results:
- 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).
- Domestic credit and interest rates are more insulated from US monetary tightening for countries that employ MaPs countercyclically.
Key concepts and variables analyzed
- Macroprudential policies (MaPs)
- Loan to value (LTV) ratio limits
- Capital adequacy ratio (CAR) limits
- External shocks: US monetary policy surprises; fluctuations in capital flows
- Net short currency mismatches (foreign currency denominated liabilities larger than foreign currency denominated assets)
- Outcomes: macro-financial volatility, GDP growth, domestic credit, interest rates
Policy implications and interpretation
- Countercyclical MaPs can serve as a buffer against external monetary tightening by insulating domestic credit and interest rates.
- Countries with net short currency mismatches are more likely to deploy countercyclical MaPs in response to surprise US monetary tightening, consistent with modeled predictions.
- There exists an inherent trade-off when using MaPs under stochastic external financial shocks: lowering macro-financial volatility may come at the cost of GDP growth, with the magnitude and direction of that trade-off depending on country-specific financial amplification characteristics.
IMF Working Paper No. 2023/012, "Macroprudential Policies in Response to External Financial Shocks", Irineu E de Carvalho Filho and DingXuan Ng, January 20, 2023.
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