Managing Capital Flows and Exchange Rates
Edited by Dongsoo Kang and Andrew Mason
Chapter 3: Business and financial cycles in emerging markets: lessons for macroprudential policies
The global financial crisis that began in 2008 highlighted the high costs of financial crises. It started a call for tools that can reduce the adverse consequences of financial volatility—including those from financial crises—for the real economy. Macroprudential policies (MAPPs) have the potential to be an essential part of any such policy toolkit. By containing complementary microprudential regulations and traditional macroeconomic management policies, notably monetary policy and fiscal policy, they would restrain the build-up of systemic risks and achieve greater stability of the financial system as a whole. A spate of recent research, both analytical and empirical, has examined the motivations for undertaking MAPPs, as well as their effectiveness once implemented. While much of the analysis to date has been motivated by the ongoing financial crisis in advanced countries (ACs), the overall use of MAPPs has been greater in emerging markets (EMs). This chapter looks at how MAPPs can be used in EMs. It begins with the following questions: What are the specific market failures and externalities that can result in the (cyclical or cross-sectional) systemic risks that would motivate the use of MAPPs? Are EMs more prone to amplification of business and financial cycles and potential systemic risks than ACs? What are the structural and conjectural factors associated with these differences between EMs and ACs? Once we establish that capital inflows are a main source of cycle amplification in EMs, we then ask: What are the policy measures, both traditional and macroprudential, that are available to EMs to reduce the associated risks and impacts? In particular, is there an even greater argument for MAPPs to be part of the overall toolkit in EMs than in ACs? If so, to what extent have EMs and other countries already used MAPPs? What is the empirical evidence to date on the effectiveness of specific MAPP instruments? Finally, what are the policy lessons for EMs given their current economic and financial conditions?
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