External debt management as macroprudential policy in a small open economy

Sekar Utami Setiastuti, Nur M. Adhi Purwanto and Aryo Sasongko

Economic Analysis and Policy, 2021, vol. 71, issue C, 446-462

Abstract: This paper examines the role of macroprudential policy and foreign exchange rate intervention in stabilizing the economy facing foreign shocks. To this end, we build a small open economy dynamic stochastic general equilibrium (DSGE) model with a banking sector. We add foreign loans by entrepreneurs regulated by a macroprudential policy via a foreign to domestic loan ratio requirement. The exchange rate intervention is undertaken via a modified Taylor rule. From the analysis, two important results emerge. First, the responses of aggregate output, consumption, investment, and inflation vary widely for different types of foreign shock and policy combinations. Second, the stabilization gain seems to depend on the type of foreign shock hitting the economy. When the economy is hit by a foreign interest rate shock, tightening the macroprudential measure reduces the volatility of output, consumption, and investment-more than if the stabilization effort is carried out through an exchange rate intervention. However, under a risk premium shock, this gain diminishes substantially.

Keywords: Exchange rate; Macroprudential policy; Credit frictions; Foreign shocks (search for similar items in EconPapers)
JEL-codes: E30 E32 E44 E51 E52 G21 G28 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecanpo:v:71:y:2021:i:c:p:446-462

DOI: 10.1016/j.eap.2021.06.002

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