EXCHANGE RATE INSULATION PROPERTIES AND THE ROLE OF MACROPRUDENTIAL POLICY IN A SMALL OPEN ECONOMY

Sekar Utami Setiastuti (s.u.setiastuti@ugm.ac.id), Nur Muhammad Adhi Purwanto (adhipd@bi.go.id) and Aryo Sasongko (aryo@bi.go.id)
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Sekar Utami Setiastuti: Universitas Gadjah Mada
Nur Muhammad Adhi Purwanto: Bank Indonesia
Aryo Sasongko: Bank Indonesia

No WP/11/2020, Working Papers from Bank Indonesia

Abstract: This paper studies the role of macroprudential policy in the insulation properties of flexible exchangerates. To this end, we build a small open economy New Keynesian DSGE model with a bankingsector where, in the model economy, entrepreneurs may take foreign loans, and the exchange rateintervention is undertaken via a modified Taylor-rule. We also add a macroprudential measure,which limits the entrepreneurs' foreign to domestic loan ratio. From the analysis, three significantresults emerge. First, the responses of aggregate output, consumption, investment, and inflation varywidely concerning the type of foreign shocks and the combinations of macroprudential policy andexchange rate intervention. Second, the flexible exchange rate's insulation properties seem to dependon the foreign shock hitting the economy. Under a foreign interest rate shock, a higher exchange rateintervention destabilizes output. Whereas under a risk premium shock, it stabilizes output. Finally, under the foreign shocks, tightening the macroprudential measure does not necessarily stabilize output in the economy.

Keywords: exchange rate; macroprudential policy; credit frictions; external shocks (search for similar items in EconPapers)
JEL-codes: E30 E32 E44 E51 E52 G21 G28 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2020
New Economics Papers: this item is included in nep-cba, nep-dge, nep-fdg, nep-mac and nep-opm
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http://publication-bi.org/repec/idn/wpaper/WP112020.pdf First version, 2020 (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:idn:wpaper:wp112020

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