Guillermo Vuletin

Reserve Requirements in the Brave New Macroprudential World (World Bank Studies) Guillermo Vuletin

In the aftermath of the global financial crisis, it is hard to find any macroeconomic policy report that does not include some reference to financial stability or systemic risk and the resulting need for 'macroprudential policies.' While there is a large and growing literature on macroprudential politics and financial stability, less attention has been paid to how macroprudential policies may facilitate macroeconomic stabilization in the presence of large capital flows.

The ultimate reason for resorting to reserve requirements lies essentially on the procyclical behavior of the exchange rate over the business cycle in developing countries (with the currency depreciating in bad times and appreciating in good times) that complicates enormously the use of interest rates as a counter cyclical instrument. Under such circumstances, reserve requirements are an effective instrument that can be used countercyclically when concerns about the effects of interest rates on the exchange rate become paramount.

Finally, Reserve Requirements in the Brave New Macroprudential World suggests that while from a macroprudential point of view, the most common macroprudential instruments are equivalent, from a microprudential one they are not. Confl icts may thus arise between micro- and macroprudential policy stances. In addition, the overall design of macroprudential policies should follow a careful analysis of the role that different financial frictions play in environments since similar symptoms can reflect very different underlying forces.

Reserve Requirements in the Brave New Macroprudential Worldlooks at the use of reserve requirements as a macroprudential tool. Its findings should be of particular interest to emerging market economists and policymakers who are faced with difficult questions regarding how to cope effectively with volatile capital flows.