Essays on the effectiveness and cyclicality of macroprudential policies in emerging markets: assessing the role of sovereign risk and implications for capital flows and financial inclusion

Abstract

This thesis empirically examines the cyclicality and impact of macroprudential policies on various macroeconomic aggregates, capital flows, and financial inclusion mainly in Emerging Markets (EMs). Using Structural Vector Autoregressions, the first chapter studies the effect of macroprudential policies on several indicators of economic activity, credit, and prices, and finds that the effectiveness of macroprudential policies differs depending on the tool being used, the type of shocks macroprudential policies respond to, and that the responsiveness of macroprudential policies could be either counter-cyclical or pro-cyclical. Generally, however, macroprudential policies were found to help lower credit growth, particularly mortgage credit, as well as housing specific inflation. The second chapter uses System Generalized Method of Moments (GMM) to examine the impact of changes in sovereign ratings – a proxy for sovereign risk – on foreign direct investment and portfolio flows across a panel of 24 EMs, whether a change in sovereign ratings displayed a contagion effect across countries, and the interaction betweens overeign ratings and macroprudential policies, both as proxies for sovereign and systemic risk respectively. This chapter sheds light on the important role of sovereign ratings for attracting FDI and portfolio flows, while the interaction between sovereign ratings and macroprudential policies highlights the effectiveness of macroprudential policies in reducing the volatility of capital flows, especially portfolio flows. The third chapter also uses system GMM to shed light on redistributive impact of macroprudential policies, mainly through their impact on financial inclusion. This chapter finds that while macroprudential policies have a mixed impact on both usage and access to financial services, macroprudential policies, conditional on increased financial development and better institutional quality, help increase financial inclusion. Each chapter in this dissertation contributes to the ongoing debate on the effectiveness of macroprudential policies; the first by examining the cyclicality of macroprudential policies, the second by examining the interaction of macroprudential policies (a proxy for systemic risk) and sovereign ratings (a proxy for sovereign risk) and the third by examining their distributional impact. The three chapters shed light on the fact that different macroprudential policies operate differently, both in terms of their cyclicality and effectiveness, in such a way that that these policies cannot operate in a one size fit all pattern, and that country-specific characteristics matter