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Spillovers, capital flows and prudential regulation in small open economies

Paul Castillo (), Cesar Carrera (), Marco Ortiz () and Hugo Vega ()

No 2014-006, Working Papers from Banco Central de Reserva del Perú

Abstract: This paper extends the model of Aoki et al. (2009) considering a two sector small open economy. We study the interaction of borrowing, asset prices, and spillovers between tradable and non-tradable sectors. Our results suggest that when it is difficult to enforce debtors to repay their debt unless it is secured by collateral, a productivity shock in the tradable sector generates an increase in asset prices and leverage that spills over to the non-tradable sector, generating an appreciation of the real exchange and an increase in domestic lending. Macro-prudential instruments are introduced under the form of cyclical loan-to-value ratios that limit the amount of capital that entrepreneurs can pledge as collateral. Cyclical taxes that respond to the movements in the price of non-tradable goods are analyzed. Simulation results show that this type of instruments significantly lessen the amplifying effects of borrowing constraints on small open economies and consequently reduce output and asset price volatility.

Keywords: Collateral; productivity; small open economy. (search for similar items in EconPapers)
JEL-codes: E21 E23 E32 E44 G01 O11 O16 (search for similar items in EconPapers)
Date: 2014-04
New Economics Papers: this item is included in nep-dge, nep-ger, nep-mac and nep-opm
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Working Paper: Spillovers, capital flows and prudential regulation in small open economies (2014) Downloads
Working Paper: Spillovers, capital ows and prudential regulation in small open economies (2014) Downloads
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