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MONETARY POLICY AND RESERVE REQUIREMENTS IN A SMALL OPEN ECONOMY

Published online by Cambridge University Press:  30 September 2020

Jose Angelo Divino  and
Carlos Haraguchi
Jose Angelo Divino
Affiliation:
Catholic University of Brasilia
Carlos Haraguchi*
Affiliation:
Central Bank of Brazil and Catholic University of Brasilia
*
Address correspondence to: Carlos Haraguchi, Banco Central do Brasil, SBS Quadra 3, Bloco B - Ed. Sede, Braslia - DF, ZIP: 70074-900, Brazil. e-mail: carlosharaguchi@gmail.com.
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Abstract

This paper investigates how a combination of monetary and macroprudential policies might affect the dynamics of a small open economy (SOE) with financial frictions under alternative discretionary shocks. Discretionary shocks in productivity and domestic and foreign monetary policies identify the roles of alternative interest rate and reserve requirement rules to stabilize the economy. The model is calibrated for the Brazilian economy. The exchange rate channel of transmission is relevant for foreign but not for domestic shocks. The interest rate rule should target domestic inflation and should not react to the exchange rate. The countercyclical reserve requirements rule, in its turn, should aggressively react to the credit-gap and not include a fixed component. Under both domestic and foreign shocks, the countercyclical effectiveness of the macroprudential policy improves when the degree of openness increases. There is a complementarity between monetary and macroprudential policy rules to stabilize the SOE.

Keywords

Monetary PolicyMacroprudential PolicySmall Open EconomyFinancial Frictions
Type
Articles
Information
Macroeconomic Dynamics , Volume 26 , Issue 4 , June 2022 , pp. 1073 - 1106
Copyright
© 2020 Cambridge University Press

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Footnotes

The authors would like to thank two anonymous referees, anonymous Associate Editor, William A. Barnett (Editor), and seminar participants in the Central Bank of Brazil, XXXVIII Brazilian Meeting of the Econometric Society, and XVII Latin American Workshop in Economic Theory for valuable comments and suggestions on the earlier versions of this paper. C. A. T. Haraguchi thanks CAPES Foundation and J. A. Divino thanks CNPq for financial support. This study was financed in part by the Coordenação de Aperfeiçoamento de Pessoal de Nvel Superior—Brasil (CAPES)—Finance Code 001. The views expressed in the paper are those of the authors and do not necessarily reflect those of the Central Bank of Brazil. All the remaining errors are the authors’ sole responsibility.

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