Exchange rate flexibility and credit during capital inflow reversals: Purgatory … not paradise

Nicolas Magud and Esteban R. Vesperoni

Journal of International Money and Finance, 2015, vol. 55, issue C, 88-110

Abstract: We identify periods of capital inflows reversals—looking at both gross and net capital flows—and document the behavior of macro and credit variables in economies with different degrees of exchange rate flexibility. We find that more exchange rate flexibility moderates credit swings during capital flow cycles, mainly because it is associated with milder credit growth during the boom. Flexibility, however, cannot completely shield the economy from a credit reversal. We observe what we dub as a recovery puzzle: credit growth in economies with more flexible exchange rate regimes remains tepid well after the capital flow reversal takes place. This results stress potential complementarity of macro-prudential policies with the exchange rate regime. More flexible regimes could help smoothing the credit cycle through capital surcharges and dynamic provisioning that build buffers to counteract the credit recovery puzzle. In contrast, more rigid exchange rate regimes would benefit the most from measures to contain excessive credit growth during booms, such as reserve requirements, loan-to-income ratios, and debt-to-income and debt-service-to-income limits.

Keywords: Capital inflows; Reversals; Credit; Macro-prudential (search for similar items in EconPapers)
JEL-codes: E32 F32 F41 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (11)

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Working Paper: Exchange Rate Flexibility and Credit during Capital Inflow Reversals: Purgatory…not Paradise (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:55:y:2015:i:c:p:88-110

DOI: 10.1016/j.jimonfin.2015.02.010

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