Working Paper: NBER ID: w29473
Authors: Chunche Chi; Stephanie Schmittgroh; MartÃn Uribe
Abstract: A central prediction of open economy models with a pecuniary externality due to a collateral constraint is that the unregulated economy overborrows relative to what occurs under optimal policy. A maintained assumption in this literature is that households borrow directly from foreign lenders. This paper shows that if foreign lending is intermediated by domestic banks and the government has access to capital controls and interest on bank reserves, the unregulated economy underborrows. The optimal bank reserve policy is countercyclical. By increasing bank reserves during contractions, the government acts as a lender of last resort to collateral-constrained households.
Keywords: bank reserves; capital controls; collateral constraints; open economy macroeconomics
JEL Codes: E58; F38; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| government policy interventions (O25) | economic outcomes (F61) |
| increasing bank reserves during economic contractions (E58) | households avoid de-leveraging during negative income shocks (G59) |
| government increasing reserves (E63) | banks lend more effectively (G21) |
| collateral constraint at household level (D10) | lending spread observed during financial crises (F65) |
| presence of banks and appropriate government policies (O16) | higher levels of external debt (F34) |
| presence of banks and appropriate government policies (O16) | less precautionary saving (E21) |