Macro-financial policies under a managed float: A simple integrated framework

Abstract

A simple integrated macroeconomic model of a small, bank-dependent open economy with a managed float and financial frictions is used to study the effects of five types of policy instruments: fiscal policy, monetary policy, macroprudential regulation, foreign exchange intervention, and capital controls. The paper also considers how, following a drop in the world interest rate, these instruments can be combined to restore the initial equilibrium. The analysis illustrates, using simple diagrams, how macro-financial policies can complement each other to manage capital inflows.In particular, it demonstrates that, to stabilize the economy, whether the response of monetary policy should be contractionary (a common prescription in practice)or expansionary depends on which other instruments are available to policymakers. The joint use of macroprudential regulation and temporary capital controls is also shown to provide, in response to external financial shocks, a potent policy combination.