Macro-prudential policies, the global financial cycle and the real exchange rate

This paper examines whether a global financial cycle originating from center economies affects the real exchange rates in peripheral economies and to what extent macroprudential policies can isolate peripheral economies from this external shock. We build a dynamic stochastic general equilibrium (DSGE) model to describe how macro-prudential policies mitigate the fluctuations of the real exchange rate in a small open economy in response to external shocks, in which households are subject to liquidity constraints. Using a sample of 37 emerging and small advanced economies, we show that a counter cyclical macro-prudential policy implementation is effective in mitigating the fluctuations in the real exchange rates caused by a U.S. interest rate shock. (C) 2019 Elsevier Ltd. All rights reserved.