Download Capital Flows and Accelerating Mechanism: An Alternative

Outline
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What does the paper do? Main contributions
Appraisal
Can this model be used for policy advice to EMEs?
On the choice of alternative policy frameworks
RR as a policy tool
Shock robustness
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Motivation, main question, and findings
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Motivated by the post-Lehman behavior of EMEs (Brasil,
Turkey, Colombia, Peru)
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Main Question: What is the appropriate mix of monetary
and macroprudential policies when changes in world
interest rate is the dominating shock?
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Answer: Using a macroprudential instrument (such as RR)
improves welfare significantly compared to IT regime.
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Each instrument (policy rate and RR) should be paired
with the objective on which it has the most influence.
(Immediate thought: do we really need a 45 equation model
to make these conclusions?)
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Methodology and Execution
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Set up a model with financial friction and nominal rigidity
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Enhanced financial accelerator, price stickiness
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Simulate the model with a foreign interest rate path
similar to the one observed in post-Lehman period.
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Rank the welfare under various policy frameworks
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Strict inflation targeting (IT) (inflation always hits the target)
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Taylor rule
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Strict IT with a macroprudential rule (reserve requirements)
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Main Contributions of the paper
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Modeling: RR’s under financial and nominal frictions
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Policy: Simulating a specific type of policy problem
which is very relevant for many EMEs.
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How to respond to capital flow cycles driven by extraordinary
movements in global interest rates?
Foreign Interest Rate
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Appraisal
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Very relevant and timely question
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Sophisticated, state of the art modeling with plenty of
useful policy implications
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Well-executed (more intuition may be helpful)
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Easy to beat strict IT or Taylor Rule
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IT or Taylor rule is not optimal (and not used in practice)
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Why not do your best with a single tool, i.e., use an optimal rule?
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Choose the parameters 𝜓𝑅 , 𝜓𝜋 , and 𝜓𝑦 in the reaction function
𝐼𝐵
𝑅𝑡𝐼𝐵
𝑅𝑡−1
log
= 𝜓𝑅 log
+ (1 − 𝜓𝑅 ) 𝜓𝜋 log 1 + 𝜋𝑡 + 𝜓𝑦 log 𝑦𝑡
1+𝑟
1+𝑟
which minimizes the loss function
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𝑇
𝑡
𝑡=1 𝛽
ln
ℎ(𝑖)𝑡 1+𝜎𝐿
𝑐(𝑖)𝑡 − 𝛾ℎ
1+𝜎𝐿
Then assess if the following alternatives improve the welfare:
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An augmented version with a direct response to credit
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Using a macroprudential instrument
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Is this an emerging economy model?
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Involves financial accelerator, rather than sudden stop:
Agency problem (Bernanke, Gertler and Gilchrist 1999) + fire sales
(Choi and Cook 2012) Acceleration mechanism is not specific to
emerging economies
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The paper includes an extended version with dollarization
but share of external credit is fixed, only valuation effects:
i*↓ , rer↑ , net worth↑ , less need for borrowing
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Credit is mostly determined by the demand side?
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The evidence shows that capital flows and credit cycles are
mainly driven by supply (leverage behavior) of global banks.
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Capital Flows and Accelerating Mechanism:
An Alternative View
Lower Global
Interest Rates
Capital Inflows
Currency appreciation
and improved networth
Easing colleteral
constraints
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Capital Flows and Accelerating Mechanism:
An Alternative View
Lower Global
Interest Rates
Capital Inflows
Currency appreciation
and improved networth
Increased supply of
external credit
Easing colleteral
constraints
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Implications for the Welfare Function
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The welfare metric used in the model:
𝑇
𝛽𝑡 ln 𝑐(𝑖)𝑡 − 𝛾ℎ
𝑊(𝑖) =
𝑡=1
ℎ(𝑖)𝑡 1+𝜎𝐿
1 + 𝜎𝐿
may not reflect the objective of the EME policy makers
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EME central banks may have an incentive to smooth credit
and exchange rate cycles directly for reasons such as:
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Inefficient composition of the output
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Overborrowing (due to pecuniary externalities)
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Probability of a sudden stop (relevant in finite sample)
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Conclusion on Turkish Monetary Policy: How fair is it?
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«In particular, while the “natural” interest rate of this
economy declines with the world rate, the policy rate may
indeed need to be increased to accommodate reserve
requirements—in contrast to the Turkey experience.»
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This conclusion reflects model specific dynamics.
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The results would have possibly changed if:
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the credit were driven by the leverage cycles of global banks (as
evidenced by Bruno and Shin 2013)
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the objective of the policy had incorporated financial stability
(reducing the probability of a sudden stop and/or BoP crisis).
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Reserve Requirements as a Macroprudential Tool
In the model RR affects credit through two channels
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Cost channel : 𝑅𝑡𝐼𝐵 −𝑅𝑡𝐷 = 𝑓(𝑠𝑡𝑀𝐴 )
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Liquidity Channel:
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What if the CB directly participates in the interbank market?
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Would liquidity channel still work? May be to a lesser extent.
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Robustness: what about «pull factors»?
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The paper considers a specific (foreign interest rate) shock,
yet draws broader conclusions regarding the policy mix.
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How would the results change if the capital flows were
driven by pull factors rather than foreign interest rates?
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A fall in country credit risk
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Productivity shock
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Capital Flows, Credit , and Exchange Rate Cycles
(HP filtered, standardized)
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Loans (t)
REER (t+2)
Inflows (t+2)
1.5
1
0.5
0
-0.5
-1
-1.5
2013Q2
2012Q4
2012Q2
2011Q4
2011Q2
2010Q4
2010Q2
2009Q4
2009Q2
2008Q4
2008Q2
2007Q4
2007Q2
2006Q4
2006Q2
2005Q4
2005Q2
2004Q4
2004Q2
-2
Source: CBRT.
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