Abstract
This paper presents a generic small open economy real business cycle model with domestic and foreign borrowing. We incorporate capital requirements and loan-to-value regulation into this framework, and subject the model to a positive foreign interest rate shock that raises the country risk premium and reduces the supply of foreign funds. The results show that both these macroprudential instruments can attenuate the impact of such a shock and that their joint application is Pareto optimal. Loan-to-value regulation delivers the largest shock attenuation benefits but entail a welfare tradeoff between borrowers and savers. Capital requirements improve the welfare of both agents, but have smaller shock attenuation benefits. Lastly, we find that a macroprudential response to foreign interest rate shocks can benefit both financial and macroeconomic stability.
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