Macroprudential Policy in the Presence of External Risks

Ricardo Reyes-Heroles and Gabriel Tenorio

No 1138, 2019 Meeting Papers from Society for Economic Dynamics

Abstract: We characterize optimal macroprudential policy in response to external risks---shocks to the level and volatility of world interest rates--in a small open economy subject to financial crises. Low and stable world interest rates reinforce overborrowing arising from a pecuniary externality generated by collateral constraints that depend on asset prices. We show that this mechanism leads to greater exposure to crises typically accompanied by abrupt increases in interest rates and a persistent rise in their volatility, as commonly observed for crises in emerging market economies. A tax on international borrowing implementing the optimal policy depends on two factors, the incidence and severity of future crises. We show that the interaction of these factors implies that the tax responds to external risks even though equilibrium allocations do not, and that it does so non-monotonically with respect to the direction of external shocks|higher macroprudential taxes are not always the optimal policy in response to an increase in external risks|.

Date: 2019
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

Downloads: (external link)
https://red-files-public.s3.amazonaws.com/meetpapers/2019/paper_1138.pdf (application/pdf)

Related works:
Journal Article: Macroprudential policy in the presence of external risks (2020)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:red:sed019:1138

Access Statistics for this paper

More papers in 2019 Meeting Papers from Society for Economic Dynamics Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA. Contact information at EDIRC.
Bibliographic data for series maintained by Christian Zimmermann ().