Financial and real shocks and the effectiveness of monetary and macroprudential policies in Latin American countries

This work compares the impact of monetary and macroprudential policies on financial and real sectors in four Latin American countries: Chile, Colombia, Mexico and Peru, and explores the commonalities and differences in the reaction to shocks to both the financial and real sector. In order to do that, we estimate a New Keynesian small open economy model with frictions in the domestic financial intermediation sector and a commodity sector for each country. Results suggest that financial shocks are important drivers of output and investment fluctuations in the short run for most countries, but in the long run their contribution is small. Furthermore, we evaluate the ability of macroprudential policies to limit the impact on credit growth and its effect on real variables. In a scenario of tighter financial conditions, monetary policy becomes expansionary due to both lower inflation (given the exchange rate appreciation) and weaker output growth, and macroprudential policies further contribute to restoring credit and output growth. However, in the case of a negative commodity price shock, macroprudential policies are less effective but useful as a complement for the tightening of monetary policy. Higher inflation (due to the exchange rate depreciation) and higher policy rates lead to a contraction in output growth, but macroprudential policies could alleviate this by improving credit conditions.