Macroprudential Policies in a Commodity Exporting Economy

BIS Working Papers No 506
July 2015

This paper, which addresses a number of aspects of macroprudential policies, was produced as part of the BIS Consultative Council for the Americas Research Network project "Incorporating financial stability consideration into central bank policy models".

Colombia is a small open and commodity exporter economy, sensitive to international commodity price fluctuations. During the surge in commodity prices, as income from the resource sector increases total credit expands, boosting demand for tradable and nontradable goods, appreciating the currency and shifting resources from the tradable sector to the nontradable. Although this adjustment is efficient, the presence of financial frictions in the economy exacerbates the resource allocation process through credit. In this phase, as total credit expands, the appreciation erodes the net worth of the tradable sector and boosts the nontradable one, and thus credit gets concentrated in that sector. A sudden reversal of commodity prices causes a rapid adjustment of resources in the opposite direction. However, the ability of the tradable sector to absorb the freed resources is limited by its financial capacity. In this scenario, macroprudential policies may help to restrain aggregate credit dynamics and thus prevent or act prudently in anticipation to the effects of large oil price shock reversals. In this work we write a model that accounts for these facts and quantify the role of three policy instruments: short term interest rate, FX intervention and financial regulation. We explore this issues in a DSGE model estimated for the Colombian economy and find that both FX intervention and regulation policies complement the short-term interest rates in smoothing the business cycle by restraining credit, raising market interest rates and smoothing economic activity. However, these additional instruments have undesirable sectoral implications. In particular, the use of these policies implies that credit to the tradable sector dries and becomes more expensive, weakening its financial position, which in turn implies a sharper fall of this sector during the price reversal and a longer recovery. These effects, nonetheless, appear to be quantitatively small according to the estimated model.

 JEL classification: E3, E58

Keywords: credit, leverage, financial accelerator, business cycle, monetary policy, macro-prudential policies, Colombia