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Macroprudential Policy in the Presence of External Risks

Author

Listed:
  • Ricardo Reyes-Heroles

    (Federal Reserve Board)

  • Gabriel Tenorio
Abstract
We characterize optimal macroprudential policy in response to external risks---shocks to the level and volatility of world interest rates--in a small open economy subject to financial crises. Low and stable world interest rates reinforce overborrowing arising from a pecuniary externality generated by collateral constraints that depend on asset prices. We show that this mechanism leads to greater exposure to crises typically accompanied by abrupt increases in interest rates and a persistent rise in their volatility, as commonly observed for crises in emerging market economies. A tax on international borrowing implementing the optimal policy depends on two factors, the incidence and severity of future crises. We show that the interaction of these factors implies that the tax responds to external risks even though equilibrium allocations do not, and that it does so non-monotonically with respect to the direction of external shocks|higher macroprudential taxes are not always the optimal policy in response to an increase in external risks|.

Suggested Citation

  • Ricardo Reyes-Heroles & Gabriel Tenorio, 2019. "Macroprudential Policy in the Presence of External Risks," 2019 Meeting Papers 1138, Society for Economic Dynamics.
    • Handle: RePEc:red:sed019:1138
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    References listed on IDEAS

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    3. Bengui, Julien & Bianchi, Javier, 2022. "Macroprudential policy with leakages," Journal of International Economics, Elsevier, vol. 139(C).

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    JEL classification:

    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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