Capital Flows and Financial Stability: Monetary Policy and Macroprudential Responses

Filiz Unsal

No 2011/189, IMF Working Papers from International Monetary Fund

Abstract: The resumption of capital flows to emerging market economies since mid 2009 has posed two sets of interrelated challenges for policymakers: (i) to prevent capital flows from exacerbating overheating pressures and consequent inflation, and (ii) to minimize the risk that prolonged periods of easy financing conditions will undermine financial stability. While conventional monetary policy maintains its role in counteracting the former, there are doubts that it is sufficient to guard against the risks of financial instability. In this context, there have been increased calls for the development of macroprudential measures, with an explicit focus on systemwide financial risks. Against this background, this paper analyses the interplay between monetary policy and macroprudential regulations in an open economy DSGE model with nominal and real frictions. The key result is that macroprudential measures can usefully complement monetary policy. Even under the "optimal policy," which calls for a rather aggressive monetary policy reaction to inflation, introducing macroprudential measures is found to be welfare improving. Broad macroprudential measures are shown to be more effective than those that discriminate against foreign liabilities (prudential capital controls). However, these measures are not a substitute for an appropriate moneraty policy reaction. Moreover, macroprudential measures are less useful in helping economic stability under a technology shock.

Keywords: WP; monetary policy; interest rate; capital controls; capital inflows; macroprudential policies; emerging markets; capital goods; open economy; equilibrium mark-up; financing costs decline; credit growth; price adjustment cost; production firm; nominal interest rate; adjustment cost; cost difference; Macroprudential policy instruments; Self-employment; Return on investment; Macroprudential policy; Global (search for similar items in EconPapers)
Pages: 27
Date: 2011-08-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (20)

Downloads: (external link)
http://www.imf.org/external/pubs/cat/longres.aspx?sk=25153 (application/pdf)

Related works:
Journal Article: Capital Flows and Financial Stability: Monetary Policy and Macroprudential Responses (2013)
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:imf:imfwpa:2011/189

Ordering information: This working paper can be ordered from
http://www.imf.org/external/pubs/pubs/ord_info.htm

Access Statistics for this paper

More papers in IMF Working Papers from International Monetary Fund International Monetary Fund, Washington, DC USA. Contact information at EDIRC.
Bibliographic data for series maintained by Akshay Modi ().