Working Paper: NBER ID: w20612
Authors: Pablo Federico; Carlos A. Vegh; Guillermo Vuletin
Abstract: Based on a novel quarterly dataset for 52 countries for the period 1970-2011, we analyze the use and cyclical properties of reserve requirements (RR) as a macroeconomic stabilization tool and whether RR policy substitutes or complements monetary policy. We find that (i) around two thirds of developing countries have used RR policy as a macroeconomic stabilization tool compared to just one third of industrial countries (and no industrial country since 2004); (ii) most developing countries that rely on RR use them countercyclically; and (iii) in many developing countries, monetary policy is procyclical and hence RR policy has substituted monetary policy as a countercyclical tool. We interpret the latter finding as reflecting the need of many emerging markets to raise interest rates in bad times to defend the currency and not raise or lower the interest rate in good times to prevent further currency appreciation. Under these circumstances, RR policy provides a second instrument that substitutes for monetary policy. Evidence from expanded Taylor rules (i.e., Taylor rules that include a nominal exchange rate target) supports these mechanisms.
Keywords: Reserve Requirements; Macroeconomic Stabilization; Monetary Policy; Emerging Markets; Countercyclical Policy
JEL Codes: E52; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Reserve Requirements (RR) (E52) | Macroeconomic Stability (E63) |
| Reserve Requirements (RR) (E52) | Countercyclical Tool in Developing Countries (O23) |
| Monetary Policy (Procyclical) (E52) | Reserve Requirements (RR) (E52) |
| Reserve Requirements (RR) (Countercyclical) (E52) | Mitigates Procyclical Monetary Policy (E52) |
| RR and Monetary Policy (Both Countercyclical) (E52) | Complements (D10) |
| Economic Downturns (F44) | Increase in Interest Rates (Defend Currency) (F31) |