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External shocks, financial volatility and reserve requirements in an open economy

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  • Agénor, Pierre-Richard
  • Alper, Koray
  • Pereira da Silva, Luiz

Abstract

The performance of a simple, countercyclical reserve requirement rule is studied in a dynamic stochastic model of a small open economy with financial frictions, imperfect capital mobility, a managed float regime, and sterilized foreign exchange market intervention. Bank funding sources, domestic and foreign, are imperfect substitutes. The model is calibrated and used to study the effects of a temporary drop in the world risk-free interest rate. Consistent with stylized facts, the shock triggers an expansion in domestic credit and activity, asset price pressures, and a real appreciation. An optimal, credit-based reserve requirement rule, based on minimizing a composite loss function, helps to mitigate both macroeconomic and financial volatility—with the latter defined both in terms of a narrow measure based on the credit-to-output ratio, the ratio of capital flows to output, and interest rate spreads, and a broader measure that includes real asset prices as well. Greater reliance on sterilization implies a less aggressive optimal reserve requirements rule, implying that the two instruments are partial substitutes.

Suggested Citation

  • Agénor, Pierre-Richard & Alper, Koray & Pereira da Silva, Luiz, 2018. "External shocks, financial volatility and reserve requirements in an open economy," Journal of International Money and Finance, Elsevier, vol. 83(C), pages 23-43.
  • Handle: RePEc:eee:jimfin:v:83:y:2018:i:c:p:23-43
    DOI: 10.1016/j.jimonfin.2018.01.003
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    Cited by:

    1. Primus, Keyra, 2017. "Excess reserves, monetary policy and financial volatility," Journal of Banking & Finance, Elsevier, vol. 74(C), pages 153-168.

    More about this item

    Keywords

    External shocks; Macroeconomic and financial stability; Reserve requirements; DSGE open-economy models;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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