Exchange Rates and Domestic Credit—Can Macroprudential Policy Reduce the Link?

By Erlend Nier, Thorvardur Tjoervi Olafsson, Yuan Gao Rollinson

September 11, 2020

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Erlend Nier, Thorvardur Tjoervi Olafsson, and Yuan Gao Rollinson. Exchange Rates and Domestic Credit—Can Macroprudential Policy Reduce the Link?, (USA: International Monetary Fund, 2020) accessed December 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

This paper examines empirically the role of macroprudential policy in addressing the effects of external shocks on financial stability. In a sample of 62 economies over the period of 2000: Q1–2016: Q4, our dynamic panel regressions show that an appreciation of the local exchange rate is associated with a subsequent increase in the domestic credit gap, while a prior tightening of macroprudential policies dampens this effect. These results are strong for small open economies, and robust when we explicitly account for potential simultaneity and reverse causality biases. We also examine a feedback effect where strong domestic credit pulls in additional cross-border funding, potentially further increasing systemic risk, and find that targeted capital controls can play a complementary role in alleviating this effect.

Subject: Balance of payments, Capital controls, Credit gaps, Domestic credit, Exchange rates, Financial sector policy and analysis, Foreign exchange, Macroprudential policy, Money, Real exchange rates

Keywords: Capital controls, Capital flow, Capital Flows, Credit development, Credit gap, Credit gaps, Currency appreciation, Domestic credit, Exchange rate, Exchange rate appreciation, Exchange rate movement, Exchange rate shock, Exchange rates, GDP ratio, Global, Macroprudential Policies, Macroprudential policy, Monetary policy, Nominal exchange rate, Real GDP, Systemic Risk, WP

Publication Details

Pages:

52
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2020/187
Stock No:

WPIEA2020187
ISBN:

9781513556550
ISSN:

1018-5941

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