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Dampening Global Financial Shocks: Can Macroprudential Regulation Help (More than Capital Controls)?
We show that macroprudential regulation can considerably dampen the impact of global financial shocks on emerging markets. More specifically, a tighter level of regulation reduces the sensitivity of GDP growth to VIX movements and capital flow shocks. A broad set of macroprudential tools contribute to this result, including measures targeting bank capital and liquidity, foreign currency mismatches, and risky forms of credit. We also find that tighter macroprudential regulation allows monetary policy to respond more countercyclically to global financial shocks. This could be an important channel through which macroprudential regulation enhances macroeconomic stability. These findings on the benefits of macroprudential regulation are particularly notable since we do not find evidence that stricter capital controls provide similar gains.
Capital Controls or Macroprudential Regulation?
International capital flows can create significant financial instability in emerging economies because of pecuniary externalities associated with exchange rate movements. Does this make it optimal to impose capital controls or should policymakers rely on domestic macroprudential regulation? This paper presents a tractable model to show that it is desirable to employ both types of instruments: Macroprudential regulation reduces overborrowing, while capital controls increase the aggregate net worth of the economy as a whole by also stimulating savings. The two policy measures should be set higher the greater an economy's debt burden and the higher domestic inequality. In our baseline calibration based on the East Asian crisis countries, we find optimal capital controls and macroprudential regulation in the magnitude of 2 percent. In advanced countries where the risk of sharp exchange rate depreciations is more limited, the role for capital controls subsides. However, macroprudential regulation remains essential to mitigate booms and busts in asset prices.
Monetary Finance: Do Not Touch, Or Handle with Care?
This paper reviews the theoretical arguments in favor and against MF and presents an empirical assessment of the risks that it may pose for inflation.
FX Intervention to Stabilize or Manipulate the Exchange Rate? Inference from Profitability
We analyze the profitability of FX swaps used by the central bank of Brazil to shed light on the rationale for FX intervention. We find that swaps are profitable in expectation, suggesting that FX intervention is used to stabilize the exchange rate in the face of temporary excessive movements rather than to manipulate it away from fundamental values. In line with this interpretation, we find that the scale of FX intervention responds to the degree of exchange rate misalignment relative to UIP conditions. We also document that intervention is more aggressive when there is less uncertainty about the medium-term level of the exchange rate and when the exchange rate is overvalued rather than undervalued.
The Expansionary Lower Bound: Contractionary Monetary Easing and the Trilemma
We provide a theory of the limits to monetary policy independence in open economies arising from the interaction between capital flows and domestic collateral constraints. The key feature of our theory is the existence of an “Expansionary Lower Bound” (ELB), defined as an interest rate threshold below which monetary easing becomes contractionary. The ELB can be positive, thus acting as a more stringent constraint than the Zero Lower Bound. Furthermore, the ELB is affected by global monetary and financial conditions, leading to novel international spillovers and crucial departures from Mundell’s trilemma. We present two models under which the ELB may arise, the first featuring carry-trade capital flows and the second highlighting the role of currency mismatches.
Monetary Policy and Credit Card Spending
We analyze the impact of monetary policy on consumer spending using credit card data. Because of their high frequency, these data improve identification and allow for a precise characterization of the transmission lags. We find that shocks to short-term interest rates affect spending much more rapidly than shocks to longer-term interest rates. We also detect significant asymmetries. While interest rate rises are contractionary, interest rate cuts are unable to lift spending. Finally, by exploiting the disaggregation of credit card data, we uncover considerable heterogeneity in the effects of monetary policy across spending categories and a stronger impact on higher-income users.
Public Debt and Household Inflation Expectations
We use randomized controlled trials in the US, UK, and Brazil to examine the causal effect of public debt on household inflation expectations. We find that people underestimate public debt levels and increase inflation expectations when informed about the correct levels. The extent of the revisions is proportional to the size of the information surprise. Confidence in the central bank considerably reduces the sensitivity of inflation expectations to public debt. We also show that people associate high public debt with stagflationary effects and that the sensitivity of inflation expectations to public debt is considerably higher for women and low-income individuals.
Optimal Reserves in Financially Closed Economies
Financially closed economies insure themselves against current-account shocks using international reserves. We characterize the optimal management of reserves using an open-economy model of precautionary savings and emphasize several results. First, the welfare-based opportunity cost of reserves differs from the measures often used by practitioners. Second, under plausible calibrations the model is consistent with the rule of thumb that reserves should be close to three months of imports. Third, simple linear rules can capture most of the welfare gains from optimal reserve management. Fourth, policymakers should place more emphasis on how to use reserves in response to shocks than on the reserve target itself.
Debt and Growth
Using a novel empirical approach and an extensive dataset developed by the Fiscal Affairs Department of the IMF, we find no evidence of any particular debt threshold above which medium-term growth prospects are dramatically compromised. Furthermore, we find the debt trajectory can be as important as the debt level in understanding future growth prospects, since countries with high but declining debt appear to grow equally as fast as countries with lower debt. Notwithstanding this, we find some evidence that higher debt is associated with a higher degree of output volatility.
Trade-offs in Bank Resolution
This SDN revisits the debate on bank resolution regimes, first by presenting a simple model of bank insolvency that transparently describes the trade-off involved between bail-outs, bail-ins, and larger capital buffers. The note then looks for empirical evidence to assess the moral hazard consequences of bail-outs and the systemic spillovers from bail-ins.
