Macroprudential policy and foreign interest rate shocks: A comparison of different instruments and regulatory regimes
Stellenbosch Working Paper Series No. WP15/2017Publication date: December 2017
Author(s):
[protected email address] (Department of Economics, University of Stellenbosch)
This paper presents a generic small open economy real business cycle model with banking and foreign borrowing. We incorporate capital requirements, reserve requirements, and loan-to-value (LTV) regulation into this framework, and subject the model to a positive foreign interest rate shock that raises the country risk premium and reduces the supply of foreign funds. The results show that these macroprudential instruments can attenuate the impact of such a shock, and that this attenuation property increases with the strictness of the regulatory regime. Capital requirements and LTV regulation deliver the largest attenuation benefits and are shown to be close substitutes. That being said, capital requirements are shown to be more effective at leaning against the financial cycle whereas LTV regulation is more effective at stimulating the financial cycle. The analysis indicates that capital and reserve requirements can interact such that reserve requirements are most effective when used to supplement existing capital requirement or LTV measures. We find that financial and macroeconomic stability objectives are aligned following a positive foreign interest rate shock such that a macroprudential response to such shocks can be to the benefit of both objectives. Lastly, our results show that capital requirements and LTV regulation exhibit decreasing returns to scale.
JEL Classification:E32, E44, E58, F38, F41, G28
Keywords:Macroprudential policy, Open economy macroeconomics, Financial stability, Business cycle, Welfare, DSGE
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Topic: "Two competing approaches in South African competition policy: merger control and anti-cartel enforcement over the past 30 years"
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13 Jun 2025 Another global flashpoint ignites as Israel attacks Iran’s nuclear facilitiesThe story for the week was initially relatively positive, with the overarching narrative being that the US and China agreed on a trade truce. However, overnight, Israel struck Iran’s nuclear facilities, military sites and killed senior commanders in dozens of strikes. While Israel has attacked Iran before, this is the first time nuclear facilities were...
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