A Conceptual Model for the Integrated Policy Framework

In emerging Asia, banks constitute the dominant source of financing consumption and investment, and bank balance sheets comprise large gross FX assets and liabilities. This paper extends the DSGE model of Gertler and Karadi (2011) to incorporate these key features and estimates a panel vector autoregression on ten Asian economies to understand the role of the banking sector in transmitting spillovers from the global financial cycle to small open economies. It also evaluates the effectiveness of foreign exchange intervention (FXI) and other macroeconomic policies in responding to external financing shocks. External financial shocks affect net external liabilities of banks and the exchange rate, leading to changes in credit supply by banks and investment. For example, a capital outflow shock leads to a deprecation that reduces the net worth and intermediation capacity of banks exposed to foreign currency liabilities. In such cases, the exchange rate acts as shock amplifier and sterilized FXI, often deployed by Asian economies, can help cushion the economy. By contrast, with real shocks, the exchange rate serves as a shock absorber, and any FXI that weakens that function can be costly. We also explore the effectiveness of the monetary policy interest rate, macroprudential policies (MPMs) and capital flow management measures (CFMs).

Section: Introductionmentioning

confidence: 99%

Bank Balance Sheets and External Shocks in Asia

Chen¹,

Nadeem²,

Peiris³

2021

“…Thus, they will now make their optimal decisions by considering a set of alternative probabilities that are not too far from the benchmark. 3 Under robustness, agents make their optimal decisions as if an "evil" agent chooses the worst-case density among all those possible distributions surrounding the benchmark. Relative to previous studies that introduce model uncertainty, two subtleties arise in our application.…”

Section: Introductionmentioning

confidence: 99%

Robust Optimal Macroprudential Policy

Montamat¹,

Roch²

2021

Self Cite

We consider how fear of model misspecification on the part of the planner and/or the households affects welfare gains from optimal macroprudential taxes in an economy with occasionally binding collateral constraints as in Bianchi ( 2011). On the one hand, there exist welfare gains from internalizing how borrowing decisions in good times affect the value of collateral during a crisis. On the other hand, interventions by a robust planner that has in mind a model far from the true underlying distribution of shocks, can result in negligible welfare gains, or even losses. This is because a policy that is robust to misspecification, as in Hansen and Sargent (2011), is optimal under a ``worst-case'' scenario but not under alternative distributions of the state. A robust planner introduces taxes that are 5 percentage points higher but does not achieve a significant increase in welfare gains compared to a non-robust planner when the true underlying model is not the worst-case. If households also make choices that are robust to model misspecification, the gains are significantly reduced and a highly-robust planner ``underborrows" and induces welfare losses. If, however, the worst-case scenario is indeed realized, then welfare gains are the largest possible.

“…Policy and analytical work on these issues has progressed at a rapid clip in recent years, including under the IMF's Integrated Policy Framework (IPF) umbrella. Basu et al (2020) provide a comprehensive model that jointly analyzes monetary, exchange rate, macroprudential and capital flow management policies and analytically solves for their optimal combination, including how these policies interact with different frictions and with each other. Adrian et al (2020) use a fullyfledged empirically oriented model which enables them to quantify the policy tradeoffs countries face and how different policy tools can be used to mitigate them.…”

Section: Introductionmentioning

confidence: 99%

Managing External Volatility

Ward¹,

Porter²,

Fayad³

et al. 2020

Since the global financial crisis, non-reserve-issuing economies (NREs) have been highly sensitive to episodes of external pressures. With monetary policy independence constrained by this sensitivity, many NREs have utilized other policy instruments. This paper confirms the vulnerability of NREs to external shocks and finds that in some circumstances managing such shocks with multiple instruments can both lessen the policy response required from any one policy tool to financial and external shocks and increase the effectiveness of policies in stabilizing macro-financial conditions. Effectiveness however does not always imply appropriateness, which rests on an evaluation of potential trade-offs and unintended consequences.