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Sudden Floods, Macroprudential Regulation and Stability in an Open Economy
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Sudden Floods, Macroprudential Regulation and Stability in an Open Economy

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  • Pierre-Richard Agénor
  • K. Alper
  • L. Pereira da Silva

Abstract

A dynamic stochastic model of a small open economy with a two-level banking intermediation structure, a risk-sensitive regulatory capital regime, and imperfect capital mobility is developed. Firms borrow from a domestic bank and the bank borrows on world capital markets, in both cases subject to a premium. A sudden flood in capital flows generates an expansion in credit and activity, as well as asset price pressures. Countercyclical capital regulation, in the form of a Basel III-type rule based on credit gaps, is effective at promoting macro stability (defined in terms of the volatility of a weighted average of inflation and the output gap) and financial stability (defined in terms of three measures based on asset prices, the credit-to-GDP ratio, and the ratio of bank foreign borrowing to GDP). However, because the gain in terms of reduced economic volatility exhibit diminishing returns, in practice a countercyclical regulatory capital rule may need to be supplemented by other, more targeted macroprudential instruments when shocks are large and persistent.

Suggested Citation

  • Pierre-Richard Agénor & K. Alper & L. Pereira da Silva, 2014. "Sudden Floods, Macroprudential Regulation and Stability in an Open Economy," Centre for Growth and Business Cycle Research Discussion Paper Series 191, Economics, The University of Manchester.
    • Handle: RePEc:man:cgbcrp:191
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    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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