Financial Openness, Bank Capital Flows, and the Effectiveness of Macroprudential Policies
CAEPR WORKING PAPER SERIES 2018-007
54 Pages Posted: 20 Aug 2018 Last revised: 27 Feb 2019
Date Written: July 1, 2018
This paper quantitatively examines the effects of macroprudential policies on credit growth in open economies. We develop a small open economy DSGE model where banks choose their funding sources (domestic vs. foreign deposits) and subject to financial constraints. Our model predicts that banks reduce leverage in response to a macroprudential policy tightening, but they increasingly rely on foreign funding. This endogenous liability composition shifts significantly undermine the stabilizing effect and welfare gains of macroprudential policies. Our results suggest macroprudential policies are less effective and should be set more aggressive in financially more open economies. Finally, we find empirical support for the model predictions in a group of developing and emerging economies.
Keywords: Credit Intermediary; Financial Frictions; Financial Openness; Macroprudential Policy
JEL Classification: E32, E44, F38, F41
Suggested Citation: Suggested Citation