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Capital Flows and Financial Stability

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  • D. Filiz Unsal

Abstract

The resumption of capital flows to emerging market economies since mid 2009 has posed two sets of interrelated challenges for policymakers: (i) to prevent capital flows from exacerbating overheating pressures and consequent inflation, and (ii) to minimize the risk that prolonged periods of easy financing conditions will undermine financial stability. While conventional monetary policy maintains its role in counteracting the former, there are doubts that it is sufficient to guard against the risks of financial instability. In this context, there have been increased calls for the development of macroprudential measures, with an explicit focus on systemwide financial risks. Against this background, this paper analyses the interplay between monetary policy and macroprudential regulations in an open economy DSGE model with nominal and real frictions. The key result is that macroprudential measures can usefully complement monetary policy. Even under the "optimal policy," which calls for a rather aggressive monetary policy reaction to inflation, introducing macroprudential measures is found to be welfare improving. Broad macroprudential measures are shown to be more effective than those that discriminate against foreign liabilities (prudential capital controls). However, these measures are not a substitute for an appropriate moneraty policy reaction. Moreover, macroprudential measures are less useful in helping economic stability under a technology shock.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 11/189.

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Length: 27
Date of creation: 01 Aug 2011
Date of revision:
Handle: RePEc:imf:imfwpa:11/189

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Keywords: Capital controls; Capital inflows; Emerging markets; Capital flows; Monetary policy; Capital goods; Corporate sector; Economic models; Financial stability; inflation; foreign currency; capital inflow; domestic borrowing; macroeconomic stability; capital stock; price elasticity; nominal interest rate; capital mobility; price level; consumer price index; inflation targeting framework; inflation targeting; aggregate demand; capital depreciation; relative price; credit expansion;

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References

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Cited by:
  1. Dominic Quint & Pau Rabanal, 2013. "Monetary and Macroprudential Policy in an Estimated DSGE Model of the Euro Area," IMF Working Papers 13/209, International Monetary Fund.
  2. Cristian Ionescu, 2011. "Micro-prudentiality and financial stability," Studies and Scientific Researches. Economics Edition, "Vasile Alecsandri" University of Bacau, Faculty of Economic Sciences, issue 16-17.
  3. Malhar Nabar & Ashvin Ahuja, 2011. "Safeguarding Banks and Containing Property Booms," IMF Working Papers 11/284, International Monetary Fund.
  4. Cristian Ionescu, 2011. "Macro-prudentiality and financial stability," Studies and Scientific Researches. Economics Edition, "Vasile Alecsandri" University of Bacau, Faculty of Economic Sciences, issue 16-17.
  5. Christopher Otrok & Gianluca Benigno & Huigang Chen & Alessandro Rebucci & Eric R. Young, 2012. "Monetary and Macro-Prudential Policies: An Integrated Analysis," Working Papers 1208, Department of Economics, University of Missouri.

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