Breaking the Trilemma: The Effects of Financial Regulations on Foreign Assets

28 Pages Posted: 15 May 2018

See all articles by David Perez-Reyna

David Perez-Reyna

Universidad de los Andes, Colombia

Mauricio Villamizar‐Villegas

Central Bank of Colombia

Date Written: May 4, 2018

Abstract

In this paper we analyze the effects of financial constraints on the exchange rate through the portfolio balance channel. Our contribution is twofold: First, we construct a tractable two-period general equilibrium model in which financial constraints inhibit capital flows. Hence, departures from the uncovered interest rate parity condition are used to explain the effects of sterilized foreign exchange intervention. Second, using high frequency data during 2004-2015, we use a sharp policy discontinuity within Colombian regulatory banking limits to empirically test for the portfolio balance channel. Consistent with our model’s postulations, our findings suggest that the effects on the exchange rate are short-lived, and significant only when banking constraints are binding.

Note: Paper produced as part of the BIS Consultative Council for the Americas (CCA) research conference on "Low interest rates, monetary policy and international spillovers" hosted by the Federal Reserve Board, Washington DC, 25–26 May.

Keywords: liquidity dependence, macro-financial linkages, Smooth Transition Bayesian VAR

JEL Classification: G2, O16, C32

Suggested Citation

Perez-Reyna, David and Villamizar‐Villegas, Mauricio, Breaking the Trilemma: The Effects of Financial Regulations on Foreign Assets (May 4, 2018). BIS Working Paper No. 718, Available at SSRN: https://ssrn.com/abstract=3174052

David Perez-Reyna (Contact Author)

Universidad de los Andes, Colombia ( email )

Carrera Primera # 18A-12
Bogota, DC D.C. 110311
Colombia

Mauricio Villamizar‐Villegas

Central Bank of Colombia ( email )

Carrera 7 No. 14-78 Piso 11
Bogotá
Colombia

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