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Macroprudential policy and foreign interest rate shocks: A comparison of loan-to-value and capital requirements

Chris Garbers and Guangling Liu

International Review of Economics & Finance, 2018, vol. 58, issue C, 683-698

Abstract: This paper presents a generic small open economy real business cycle model with domestic and foreign borrowing. We incorporate capital requirements and loan-to-value regulation into this framework, and subject the model to a positive foreign interest rate shock that raises the country risk premium and reduces the supply of foreign funds. The results show that both these macroprudential instruments can attenuate the impact of such a shock and that their joint application is Pareto optimal. Loan-to-value regulation delivers the largest shock attenuation benefits but entail a welfare tradeoff between borrowers and savers. Capital requirements improve the welfare of both agents, but have smaller shock attenuation benefits. Lastly, we find that a macroprudential response to foreign interest rate shocks can benefit both financial and macroeconomic stability.

Keywords: Macroprudential policy; Open economy macroeconomics; Financial stability; Business cycle; Equity premium; Welfare; DSGE (search for similar items in EconPapers)
JEL-codes: E32 E44 E58 F38 F41 G28 (search for similar items in EconPapers)
Date: 2018
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Handle: RePEc:eee:reveco:v:58:y:2018:i:c:p:683-698