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Optimal v. simple financial policy rules in a production economy with “liability dollarization

Author

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  • Juan M. Hernandez

    (University of Pennsylvania, Philadelphia, United States)

  • Enrique G. Mendoza

    (University of Pennsylvania, NBER & PIER, Philadelphia, United StatesAuthor-Name: Juan M. Hernandez
    University of Pennsylvania, Philadelphia, United States)

Abstract

We evaluate the effectiveness of financial policy rules in a small open economy with production, liability dollarization and “unconventional shocks” (global liquidity shifts and news about future fundamentals). Tradable and nontradable final goods are produced with tradable inputs. Debt is denominated in units of tradables and cannot exceed a fraction of the market value of total income. Optimal policy has a macroprudential or ex-ante component (a debt tax levied at date t only when the credit constraint may bind at t+1), and ex-post components (sectoral production taxes/subsidies used when the constraint binds). The optimal policy reduces sharply the frequency and severity of financial crises but is also very complex. Simple policies are less effective and can be welfare reducing.

Suggested Citation

  • Juan M. Hernandez & Enrique G. Mendoza, 2017. "Optimal v. simple financial policy rules in a production economy with “liability dollarization," Revista ESPE - Ensayos sobre Política Económica, Banco de la Republica de Colombia, vol. 35(82), pages 25-39, April.
    • Handle: RePEc:bdr:ensayo:v:35:y:2017:i:82:p:25-39
    DOI: 10.1016/j.espe.2017.01.004
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    Cited by:

    1. Enrique G. Mendoza & Eugenio Rojas, 2019. "Positive and Normative Implications of Liability Dollarization for Sudden Stops Models of Macroprudential Policy," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 67(1), pages 174-214, March.
    2. Miguel Acosta-Henao & Laura Alfaro & Andrés Fernández, 2020. "Sticky Capital Controls," NBER Working Papers 26997, National Bureau of Economic Research, Inc.
    3. Javier Bianchi & Enrique Mendoza, 2020. "A Fisherian Approach to Financial Crises: Lessons from the Sudden Stops Literature," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 37, pages 254-283, August.
    4. Enrique G. Mendoza, 2017. "Política macroprudencial: promesas y desafíos," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 20(2), pages 042-088, August.
    5. Enrique G. Mendoza, 2018. "Macroprudential Policy: Promise and Challenges," Central Banking, Analysis, and Economic Policies Book Series, in: Enrique G. Mendoza & Ernesto Pastén & Diego Saravia (ed.),Monetary Policy and Global Spillovers: Mechanisms, Effects and Policy Measures, edition 1, volume 25, chapter 7, pages 225-277, Central Bank of Chile.

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    More about this item

    Keywords

    Crisis financieras; Política macro-prudencial; Estabilidad financiera; Riesgo sistémico; Liquidez global; Choques de noticias;
    All these keywords.

    JEL classification:

    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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