Sudden Floods, Macroprudential Regulation and Stability in an Open Economy

Pierre-Richard Agénor, Koray Alper and Luiz Awazu Pereira da Silva (luiz.apereira@lapds.org)

Centre for Growth and Business Cycle Research Discussion Paper Series from Economics, The University of Manchester

Abstract: A dynamic stochastic model of a small open economy with a two-level banking intermediation structure, a risk-sensitive regulatory capital regime, and imperfect capital mobility is developed. Firms borrow from a domestic bank and the bank borrows on world capital markets, in both cases subject to a premium. A sudden flood in capital flows generates an expansion in credit and activity, as well as asset price pressures. Countercyclical capital regulation, in the form of a Basel III-type rule based on credit gaps, is effective at promoting macro stability (defined in terms of the volatility of a weighted average of inflation and the output gap) and financial stability (defined in terms of three measures based on asset prices, the credit-to-GDP ratio, and the ratio of bank foreign borrowing to GDP). However, because the gain in terms of reduced economic volatility exhibit diminishing returns, in practice a countercyclical regulatory capital rule may need to be supplemented by other, more targeted macroprudential instruments when shocks are large and persistent.

Pages: 46 pages
Date: 2014
New Economics Papers: this item is included in nep-ban, nep-cba, nep-mac, nep-opm, nep-reg and nep-rmg
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Citations: View citations in EconPapers (33)

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Related works:
Working Paper: Sudden Floods, Macroprudential Regulation and Stability in an Open Economy (2015)
Journal Article: Sudden floods, macroprudential regulation and stability in an open economy (2014)
Working Paper: Sudden Floods, Macroprudential Regulation and Stability in an Open Economy (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:man:cgbcrp:191

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