Macroprudential rules in small open economies

Available from: 
October 2013
Paper author(s): 
Maria Alejandra Amado Garfias (Center for Global Development)
Macroeconomics - Economic growth - Monetary Policy

This research aims to evaluate the effectiveness, in terms of macroeconomic stability, of monetary policy rules and instruments of prudential supervision. Specifically, it seeks to distinguish between the gains of including in the standard monetary policy rule indicators of financial stress, such as credit growth –augmented rule-; and the gains of applying, in parallel to this augmented rule, a macroprudential instrument that allows a supervisory authority to affect credit interest rates directly. This analysis is performed using a dynamic stochastic general equilibrium model for a small open economy with financial rigidities, and is evaluated in the context of four shocks: financial, productivity, foreign demand and foreign interest rate. The results obtained suggest that the effectiveness of the rules depends strongly on the nature of the shock affecting the economy. In particular, in face of a financial shock, an augmented Taylor rule in combination with a macroprudential instrument is the most effective in reducing the volatility of the economy. However, when the shock does not affect credit supply conditions directly, rules that react to credit growth will increase macroeconomic volatility. Therefore, under productivity, external demand and foreign interest rate shocks, the most effective rule is the simple Taylor rule.


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Research section: 
Lacea 2013 annual meeting
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