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Foreign Capital Flows, Credit Growth and Macroprudential Policy in a DSGE Model with Traditional and Matter-of-Fact Financial Frictions

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  • Fabia A. de Carvalho
  • Marcos R. Castro

Abstract

We investigate the transmission channel of reserve requirements, capital requirements, and risk weights of different types of credit in the computation of capital adequacy ratios and compare the power of each macroprudential instrument to counteract the impact of domestic and international shocks that potentially challenge financial stability. To this end, we model a small open economy that receives inflows of foreign direct investment, foreign portfolio investment, and issues foreign debt. The central bank manages international reserves, with an impact on the foreign exchange market and on the country risk premium. Shocks in international markets affect domestic credit even though foreign capital flows are directly destined to non-financial institutions. Banks operate in four distinct credit markets: consumer, housing and commercial– each of them facing default risk and having specific borrowing constraints– and safe export-related credit lines in the form of working capital loans to exporters. Consumer loans are granted based on banks’ expectations with respect to borrowers’ future labor income net of senior debt services. Banks optimize their balance sheet allocation facing frictions intended to reproduce banks’ incentives given regulatory constraints. The model is estimated with Bayesian techniques using data from Brazil.

Suggested Citation

  • Fabia A. de Carvalho & Marcos R. Castro, 2015. "Foreign Capital Flows, Credit Growth and Macroprudential Policy in a DSGE Model with Traditional and Matter-of-Fact Financial Frictions," Working Papers Series 387, Central Bank of Brazil, Research Department.
    • Handle: RePEc:bcb:wpaper:387
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    References listed on IDEAS

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    1. Carlos Montoro & Ramon Moreno, 2011. "The use of reserve requirements as a policy instrument in Latin America," BIS Quarterly Review, Bank for International Settlements, March.
    2. Fabia Carvalho & Fabia A. de Carvalho & Silvio Michael de Azevedo Costa & Marcos Ribeiro de Castro, 2013. "Traditional and matter-of-fact financial frictions in a DSGE model for Brazil: the role of macroprudential instruments and monetary policy," EcoMod2013 5145, EcoMod.
    3. Roberto Motto & Massimo Rostagno & Lawrence J. Christiano, 2010. "Financial Factors in Economic Fluctuations," 2010 Meeting Papers 141, Society for Economic Dynamics.
    4. Fabia Aparecida de Carvalho & Cyntia F. Azevedo, 2008. "The incidence of reserve requirements in Brazil: Do bank stockholders share the burden?," Journal of Applied Economics, Universidad del CEMA, vol. 11, pages 61-90, May.
    5. Fabia A. de Carvalho & Cyntia F. Azevedo, 2008. "The Incidence of Reserve Requirements in Brazil: Do Bank Stockholders Share the Burden?," Journal of Applied Economics, Taylor & Francis Journals, vol. 11(1), pages 61-90, May.
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    2. Divino, Jose Angelo & Haraguchi, Carlos, 2022. "Monetary Policy And Reserve Requirements In A Small Open Economy," Macroeconomic Dynamics, Cambridge University Press, vol. 26(4), pages 1073-1106, June.
    3. Georgiadis, Georgios & Jančoková, Martina, 2020. "Financial globalisation, monetary policy spillovers and macro-modelling: Tales from 1001 shocks," Journal of Economic Dynamics and Control, Elsevier, vol. 121(C).
    4. Leonardo Nogueira Ferreira & Márcio Issao Nakane, 2018. "Macroprudential policy in a DSGE model: anchoring the countercyclical capital buffer," Economics Bulletin, AccessEcon, vol. 38(4), pages 2345-2352.
    5. Fabia A. de Carvalho & Marcos R. de Castro, 2015. "Macroprudential and Monetary Policy Interaction: a Brazilian perspective," Working Papers Series 405, Central Bank of Brazil, Research Department.
    6. Fabia A. Carvalho & Marcos R. Castro, 2017. "Macroprudential policy transmission and interaction with fiscal and monetary policy in an emerging economy: a DSGE model for Brazil," Macroeconomics and Finance in Emerging Market Economies, Taylor & Francis Journals, vol. 10(3), pages 215-259, September.
    7. Gulan, Adam & Jokivuolle, Esa & Verona, Fabio, 2022. "Optimal bank capital requirements: What do the macroeconomic models say?," BoF Economics Review 2/2022, Bank of Finland.
    8. Marcos R. Castro, 2019. "Sectoral Countercyclical Buffers in a DSGE Model with a Banking Sector," Working Papers Series 503, Central Bank of Brazil, Research Department.
    9. Rodríguez, Aldo, 2020. "Estimación Bayesiana de un Modelo de Economía Abierta con Sector Bancario," Dynare Working Papers 52, CEPREMAP.
    10. Mădălin Viziniuc, 2017. "Potential Gains from Cooperation Between Monetary and Macroprudential Policies: The Case of an Emerging Economy," Eastern European Economics, Taylor & Francis Journals, vol. 55(5), pages 420-452, September.
    11. Bank for International Settlements, 2016. "Experiences with the ex ante appraisal of macroprudential instruments," CGFS Papers, Bank for International Settlements, number 56, October –.

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