Credit Cycles and Macroprudential Policy Framework in Emerging Countries

Abstract

Due to large and unprecedented quantitative easing policies and the prevailing policy uncertainty in advanced economies, many emerging countries have faced large and excessively volatile short-term capital flows during the recent era. If not managed properly and timely, such flows can give rise to an amplified cycle of steady appreciation of the currency, a strong rise in asset prices, looser credit market conditions, and build-up of balance sheet risks. This fragility may eventually trigger a sudden reversal of such flows (often called “sudden stop”), leading to a sharp currency depreciation and a large contraction in credit and output. In turn, to reduce the build-up of financial stability risks and contain ‘excessive’ cycles in credit market conditions, emerging countries have increasingly utilised macroprudential policy tools.

In this paper, we assess how macroprudential policy tools perform in major emerging countries in containing ‘excessive’ credit cycles. In particular, we first compile an index of policy stance for widely used macroprudential tools, using existing databases on macroprudential policy actions and national sources. We then study whether changes in the policy stance contain ‘excessive’ cycles in domestic credit, and particularly from the perspective of emerging countries, whether they help contain excessive credit cycles due to fluctuations in capital inflows.

Full publication: Macroprudential Policy