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Discussion of « Monetary and Macroprudential Policies to Manage Capital Flows » by Juan Pablo Medina and Jorge R

Discussion of « Monetary and Macroprudential Policies to Manage Capital Flows » by Juan Pablo Medina and Jorge Roldós Hakan Kara Central Bank of the Republic of Turkey 2013 CENTRAL BANK MACROECONOMIC MODELING WORKSHOP

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Discussion of « Monetary and Macroprudential Policies to Manage Capital Flows » by Juan Pablo Medina and Jorge R

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  1. Discussion of«Monetary and Macroprudential Policies to Manage Capital Flows» by Juan Pablo Medina and Jorge Roldós Hakan KaraCentral Bank of theRepublicof Turkey 2013 CENTRAL BANK MACROECONOMIC MODELING WORKSHOP “Understanding the Mechanisms and Effects of New Policy Instruments” November 7-8, 2013 İstanbul

  2. Outline • Whatdoesthepaper do? Main contributions • Appraisal • Can this model be usedforpolicyadvicetoEMEs? • On thechoice of alternativepolicyframeworks • RR as a policytool • Shockrobustness

  3. Motivation, main question, andfindings • Motivatedbythe post-Lehmanbehavior of EMEs(Brasil, Turkey, Colombia, Peru) • Main Question: What is theappropriate mix of monetaryandmacroprudentialpolicieswhenchanges in worldinterest rate is thedominatingshock? • Answer: Using a macroprudentialinstrument(such as RR) improveswelfaresignificantlycomparedto IT regime. • Each instrument(policy rate and RR) should be paired with the objective on which it hasthe most influence. (Immediatethought: do wereallyneeda 45 equation model tomaketheseconclusions?)

  4. MethodologyandExecution • Set up a model withfinancialfrictionand nominal rigidity • Enhancedfinancialaccelerator, pricestickiness • Simulatethe model with a foreigninterest rate pathsimilartotheoneobserved in post-Lehmanperiod. • Rankthewelfareundervariouspolicyframeworks • Strictinflationtargeting (IT) (inflationalwayshitsthetarget) • Taylor rule • Strict IT with a macroprudentialrule (reserverequirements)

  5. Main Contributions of thepaper • Modeling: RR’sunderfinancialand nominal frictions • Policy: Simulating a specifictype of policy problem which is veryrelevantformanyEMEs. • How torespondtocapitalflowcyclesdrivenbyextraordinarymovements in global interestrates? ForeignInterest Rate

  6. Appraisal • Veryrelevantandtimelyquestion • Sophisticated, state of the art modelingwithplenty of usefulpolicyimplications • Well-executed (moreintuitionmay be helpful)

  7. Easytobeatstrict IT or Taylor Rule • IT or Taylor ruleis not optimal (and not used in practice) • Whynot do yourbestwith a singletool, i.e., use an optimal rule? • Choose the parameters , , and in thereactionfunction which minimizes the loss function • Thenassessifthefollowingalternativesimprovethewelfare: • An augmentedversionwith a directresponsetocredit • Using a macroprudentialinstrument

  8. Is this an emergingeconomy model? • Involvesfinancialaccelerator, ratherthansudden stop: Agency problem (Bernanke, GertlerandGilchrist 1999) + fire sales (ChoiandCook 2012) Acceleration mechanism is not specifictoemergingeconomies • Thepaperincludes an extendedversionwithdollarization but share of externalcredit is fixed, onlyvaluationeffects: i*↓ , rer↑ , net worth↑ , lessneedforborrowing • Credit is mostlydeterminedbythedemandside? • Theevidenceshowsthatcapitalflowsandcreditcyclesaremainlydrivenbysupply (leveragebehavior) of global banks.

  9. CapitalFlowsandAcceleratingMechanism: An AlternativeView Lower Global InterestRates CapitalInflows Currencyappreciation andimprovednetworth Easingcolleteralconstraints

  10. CapitalFlowsandAcceleratingMechanism: An AlternativeView Lower Global InterestRates CapitalInflows Currencyappreciation andimprovednetworth Increasedsupply of externalcredit Easingcolleteralconstraints

  11. ImplicationsfortheWelfareFunction • Thewelfaremetricused in the model: may not reflecttheobjective of the EME policymakers • EME centralbanksmayhave an incentivetosmoothcreditandexchange rate cyclesdirectlyforreasonssuch as: • Inefficientcomposition of theoutput • Overborrowing (duetopecuniaryexternalities) • Probability of a sudden stop (relevant in finitesample)

  12. Conclusion on TurkishMonetaryPolicy: How fair is it? • «In particular, while the “natural” interest rate of this economy declines with the world rate, the policy rate may indeed need to be increased to accommodate reserve requirements—in contrast to the Turkey experience.» • Thisconclusionreflects model specificdynamics. • Theresultswouldhavepossiblychangedif: • thecreditweredrivenbytheleveragecycles of global banks (as evidencedbyBrunoandShin 2013) • theobjective of thepolicy had incorporatedfinancialstability (reducingtheprobability of a sudden stop and/orBoPcrisis).

  13. ReserveRequirements as a MacroprudentialTool Inthe model RR affectscreditthroughtwochannels • Costchannel: • Liquidity Channel: • Whatifthe CB directlyparticipates in theinterbank market? • Wouldliquiditychannelstillwork? May be to a lesserextent.

  14. Robustness: whatabout «pullfactors»? • Thepaperconsiders a specific (foreigninterest rate) shock, yet drawsbroaderconclusionsregardingthepolicy mix. • How wouldtheresultschangeifthecapitalflowsweredrivenbypullfactorsratherthanforeigninterestrates? • A fall in countrycredit risk • Productivity shock

  15. Discussion of«Monetary and Macroprudential Policies to Manage Capital Flows» by Juan Pablo Medina and Jorge Roldós Hakan KaraCentral Bank of theRepublicof Turkey 2013 CENTRAL BANK MACROECONOMIC MODELING WORKSHOP “Understanding the Mechanisms and Effects of New Policy Instruments” November 7-8, 2013 İstanbul

  16. CapitalFlows, Credit , andExchange Rate Cycles (HP filtered, standardized) Source: CBRT.

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