Macro-prudential policies, the global financial cycle and the real exchange rate. (September 2019)

• Record Type: Journal Article
• Authors: Ouyang, Alice Y.; Guo, Shen
• Is Part Of: Journal of international money and finance. Volume 96(2019)
• Page Start: 147
• Page End: 167
• Publication Date: 2019-09
• Subjects: E44 -- F41 -- F42; Macro-prudential policies -- Global financial cycle -- Real exchange rate -- U.S. interest rate -- Global liquidity -- Reserve requirement -- Loan-to-value ratio; International finance -- Periodicals; Foreign exchange -- Periodicals; Finances internationales -- Périodiques; Change -- Périodiques; Foreign exchange; International finance; Periodicals; 332.04205
• DOI: 10.1016/j.jimonfin.2019.05.009
• Languages: English
• ISSNs: 0261-5606

Abstract

Highlights: We find evidence of the existence of a global financial cycle. Counter-cyclical macro-prudential policies are effective in serving as shock absorbers of real exchange rate fluctuations. Macro-prudential policies work more effectively in response to U.S. monetary expansionary shocks. Reserve requirements and loan-to-value limits are effective instruments. Macro-prudential policies work more effectively in a more flexible exchange rate regime. Abstract: This paper examines whether a global financial cycle originating from center economies affects the real exchange rates in peripheral economies and to what extent macro-prudential policies can isolate peripheral economies from this external shock. We build a dynamic stochastic general equilibrium (DSGE) model to describe how macro-prudential policies mitigate the fluctuations of the real exchange rate in a small open economy in response to external shocks, in which households are subject to liquidity constraints. Using a sample of 37 emerging and small advanced economies, we show that a counter-cyclical macro-prudential policy implementation is effective in mitigating the fluctuations in the real exchange rates caused by a U.S. interest rate shock.