Camilo Granados

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Working Papers

Strategic Macroprudential Policymaking: When Does Cooperation Pay Off?

Abstract
I study whether emerging economies can navigate the global financial cycle more successfully by resorting to internationally coordinated macroprudential policies. For this, I set an open economy model with banking frictions in a center-periphery environment with multiple emerging economies. Then, I evaluate the performance of several policy arrangements that differ by the degree and type of cooperation. I find that cooperation can generate welfare gains but is not always beneficial relative to nationally-oriented policies. Instead, only regimes where the financial center acts cooperatively generate welfare gains. When present, two mechanisms generate the gains: a cancellation effect of national incentives to manipulate the global interest rate and a motive for steering capital flows to emerging economies. The first mechanism eliminates unnecessary policy fluctuations and the second helps prevent capital retrenchments in the center. These effects can be quantitatively relevant as good cooperation regimes can reduce the welfare losses induced by a financial friction between 60% and 80%.

Abstract

I study whether emerging economies can navigate the global financial cycle more successfully by resorting to internationally coordinated macroprudential policies. For this, I set an open economy model with banking frictions in a center-periphery environment with multiple emerging economies. Then, I evaluate the performance of several policy arrangements that differ by the degree and type of cooperation. I find that cooperation can generate welfare gains but is not always beneficial relative to nationally-oriented policies. Instead, only regimes where the financial center acts cooperatively generate welfare gains. When present, two mechanisms generate the gains: a cancellation effect of national incentives to manipulate the global interest rate and a motive for steering capital flows to emerging economies. The first mechanism eliminates unnecessary policy fluctuations and the second helps prevent capital retrenchments in the center. These effects can be quantitatively relevant as good cooperation regimes can reduce the welfare losses induced by a financial friction between 60% and 80%.

[Paper] / [Slides (30 min)] / [Video (until 21:48)]

Macroprudential Policy Interactions: What has Changed Since the Global Financial Crisis?

Abstract
We study the empirical international policy interactions between macroprudential regulators with the objective of determining whether these adjust their policies with cross-border strategic considerations in mind. For that, we analyze the policy-to-policy interactions for a panel of 65 economies using a local projection approach. Our findings suggest that domestic regulators do react in response to foreign policy changes positively and on average will tighten their domestic tools in response to stricter foreign financial regulations (tightenings). We apply additional specifications to disentangle the average policy effect and obtain that: (i) regulators react mainly to policy changes in advanced economies, (ii) the reaction to foreign policy changes is stronger in advanced economies, (iii) reactions to emerging regulations are less important, but can exist at the regional level (emerging-to-emerging). Additionally, results by type of foreign policy instruments suggest that, other than the typical positive response in our baseline, there can also be occasional loosening adjustments in emerging economies after foreign policy tightenings of some prudential instruments. Our results point to the existence of important policy interactions that can create the scope for coordinated policy frameworks aimed to mitigate inefficiencies in the level of macroprudential interventionism.

Abstract

We study the empirical international policy interactions between macroprudential regulators with the objective of determining whether these adjust their policies with cross-border strategic considerations in mind. For that, we analyze the policy-to-policy interactions for a panel of 65 economies using a local projection approach. Our findings suggest that domestic regulators do react in response to foreign policy changes positively and on average will tighten their domestic tools in response to stricter foreign financial regulations (tightenings). We apply additional specifications to disentangle the average policy effect and obtain that: (i) regulators react mainly to policy changes in advanced economies, (ii) the reaction to foreign policy changes is stronger in advanced economies, (iii) reactions to emerging regulations are less important, but can exist at the regional level (emerging-to-emerging). Additionally, results by type of foreign policy instruments suggest that, other than the typical positive response in our baseline, there can also be occasional loosening adjustments in emerging economies after foreign policy tightenings of some prudential instruments. Our results point to the existence of important policy interactions that can create the scope for coordinated policy frameworks aimed to mitigate inefficiencies in the level of macroprudential interventionism.

[Paper]

Macroprudential Policy Leakages in Open Economies: A Multiperipheral Approach. R&R at Macroeconomic Dynamics

Abstract
To understand the international nature of the macroprudential policy and the potential cross-border regulatory leakages these imply we develop a three-country center-periphery framework with financial frictions and limited financial intermediation in emerging economies. Each country has a macroprudential instrument to smooth credit spread distortions; however, the banking regulations can leak to other economies and be subject to costs. Our results show the presence of cross-border regulation spillovers that increase with the extent of financial frictions, that are driven by the capacity of the regulation to limit aggregate intermediation, and that can be magnified if policymakers are forward-looking. We discuss the policy implications of the resulting macroprudential interdependence and the potential scope for policy design that improves the management of the trade-off between mitigating the financial frictions and curtailing intermediation.

Abstract

To understand the international nature of the macroprudential policy and the potential cross-border regulatory leakages these imply we develop a three-country center-periphery framework with financial frictions and limited financial intermediation in emerging economies. Each country has a macroprudential instrument to smooth credit spread distortions; however, the banking regulations can leak to other economies and be subject to costs. Our results show the presence of cross-border regulation spillovers that increase with the extent of financial frictions, that are driven by the capacity of the regulation to limit aggregate intermediation, and that can be magnified if policymakers are forward-looking. We discuss the policy implications of the resulting macroprudential interdependence and the potential scope for policy design that improves the management of the trade-off between mitigating the financial frictions and curtailing intermediation.

[Paper]

Dissecting Capital Flows: Do Capital Controls Shield Against Foreign Shocks? R&R at Journal of Financial Stability (with Kyongjun Kwak)

Abstract
To rationalize the increased use of capital flows regulations in recent times, we study the capacity of capital flow management measures (CFMs) to insulate an economy from external shocks. We examine the extent to which CFMs mitigate the effects of US monetary shocks and whether measuring this mitigation at the net or gross level of flows matters. Our analysis is carried out for a panel of emerging market economies and for different disaggregations of the flows. Our results indicate that the level of aggregation matters for evaluating the effects of CFMs, and that analyses with excessively aggregated flows or with only net measures may lead to biases in assessing the insulation features of the CFMs. Furthermore, CFMs have insulation properties that mitigate capital repatriations; however, these are mostly related to risky portfolio and banking flows.

Abstract

To rationalize the increased use of capital flows regulations in recent times, we study the capacity of capital flow management measures (CFMs) to insulate an economy from external shocks. We examine the extent to which CFMs mitigate the effects of US monetary shocks and whether measuring this mitigation at the net or gross level of flows matters. Our analysis is carried out for a panel of emerging market economies and for different disaggregations of the flows. Our results indicate that the level of aggregation matters for evaluating the effects of CFMs, and that analyses with excessively aggregated flows or with only net measures may lead to biases in assessing the insulation features of the CFMs. Furthermore, CFMs have insulation properties that mitigate capital repatriations; however, these are mostly related to risky portfolio and banking flows.

[Paper]

Work in Progress

Terms of Trade Fluctuations and Sudden Stops in A Small Open Economy.(with Andrew Faris)

Abstract
We examine how terms-of-trade fluctuations can shape the vulnerability of emerging economies to self-fulfilling financial crises and sudden stops. Building on a small open economy endowment model with importables, exportables, and nontradables, we allow the borrowing constraint to depend explicitly on the relative price of exports. This channel links terms-of-trade movements to the economy’s collateral capacity. We find that while terms-of-trade shocks may play a limited role in routine business-cycle dynamics, their importance intensifies under stressed conditions. Favorable terms-of-trade can deter the emergence of multiple equilibria and prevent expectation-driven crises. Our findings contribute to understanding the high relevance associated to the terms-of-trade in emerging economies, even in presence of the limited evidence of their importance as a fundamental driver during normal times.

Abstract

We examine how terms-of-trade fluctuations can shape the vulnerability of emerging economies to self-fulfilling financial crises and sudden stops. Building on a small open economy endowment model with importables, exportables, and nontradables, we allow the borrowing constraint to depend explicitly on the relative price of exports. This channel links terms-of-trade movements to the economy’s collateral capacity. We find that while terms-of-trade shocks may play a limited role in routine business-cycle dynamics, their importance intensifies under stressed conditions. Favorable terms-of-trade can deter the emergence of multiple equilibria and prevent expectation-driven crises. Our findings contribute to understanding the high relevance associated to the terms-of-trade in emerging economies, even in presence of the limited evidence of their importance as a fundamental driver during normal times.

[Paper]

Prices Stability and Macroeconomic Volatility Spillovers in Latin America

Abstract
In order to determine the presence of volatility spillovers among macroeconomic variables a Vector Autorregresive (VAR) model with multivariate heteroskedasticity effects is carried out for five countries in Latin America. The variables considered are real activity, price level, interest rate, and exchange rate. The results indicate that there are few within country volatility spillovers. Those that are significant are usually sizable and point to the relevance of international shocks in spreading volatility to other countries rather than local effects. Finally, we obtain that the volatility of inflation is not generally affected by the uncertainty shocks in the exchange rate, this result is noticeable as the price instability effects of the exchange rate fluctuations is usually the justification behind exchange rate intervention programs in these economies.

Abstract

In order to determine the presence of volatility spillovers among macroeconomic variables a Vector Autorregresive (VAR) model with multivariate heteroskedasticity effects is carried out for five countries in Latin America. The variables considered are real activity, price level, interest rate, and exchange rate. The results indicate that there are few within country volatility spillovers. Those that are significant are usually sizable and point to the relevance of international shocks in spreading volatility to other countries rather than local effects. Finally, we obtain that the volatility of inflation is not generally affected by the uncertainty shocks in the exchange rate, this result is noticeable as the price instability effects of the exchange rate fluctuations is usually the justification behind exchange rate intervention programs in these economies.

[Paper]

Enhancing Economic Resiliency Through Prudential Cooperation

Abstract
I analyze the short-run resilience and financial stability properties of an array of cooperative policy regimes relative to nationally-oriented regulations. I show that countries that rely on internationally coordinated policies are more insulated to the negative effects of international financial downturns like the global financial crisis. Additionally, cooperative policies allow countries to increase the countercyclicality of the prudential policies, to lower the required level of interventionism to deal with crises, and to mitigate the deleveraging processes after a financial crisis. All of these properties imply that smoother and less volatile policy responses can be compatible with improved economic performance after external shocks which makes a case for the implementation of coordinated policy schemes that go beyond the potential welfare gains involved in these initiatives.

Abstract

I analyze the short-run resilience and financial stability properties of an array of cooperative policy regimes relative to nationally-oriented regulations. I show that countries that rely on internationally coordinated policies are more insulated to the negative effects of international financial downturns like the global financial crisis. Additionally, cooperative policies allow countries to increase the countercyclicality of the prudential policies, to lower the required level of interventionism to deal with crises, and to mitigate the deleveraging processes after a financial crisis. All of these properties imply that smoother and less volatile policy responses can be compatible with improved economic performance after external shocks which makes a case for the implementation of coordinated policy schemes that go beyond the potential welfare gains involved in these initiatives.

[Paper]

Financial Regulation and Income Inequality (with Jasmine Jiang)

Publications

Exchange Rate Dynamics and the Central Bank’s Balance Sheet (with Guillermo Gallacher and Janelle Mann) Journal of International Money and Finance. Volume 148, October 2024.

Abstract
Are nominal exchange rate variations linked to the central bank’s balance sheet, and in particular to remunerated domestic liabilities? We use two metrics of implied exchange rates using central bank balance sheet data: one is a traditional metric that includes the monetary base, and the other adds remunerated domestic liabilities. We first estimate a VAR model to investigate the endogenous interactions between central bank balance sheet components for a set of seven Latin American countries for the 2006:01-2019:12 period. Then, we use threshold cointegration techniques to compare these two metrics of the implied exchange rate with the spot (observed) exchange rate. We find that the implied exchange rates and the spot exchange rate are cointegrated for most of the set of Latin American countries. We also find that for a subset of our sample, the spot exchange rate adjusts to the metric that adds remunerated domestic liabilities. We conclude the remunerated domestic liabilities matter for understanding exchange rate dynamics and explore a simple theoretical setup to better understand the mechanism.

Abstract

Are nominal exchange rate variations linked to the central bank’s balance sheet, and in particular to remunerated domestic liabilities? We use two metrics of implied exchange rates using central bank balance sheet data: one is a traditional metric that includes the monetary base, and the other adds remunerated domestic liabilities. We first estimate a VAR model to investigate the endogenous interactions between central bank balance sheet components for a set of seven Latin American countries for the 2006:01-2019:12 period. Then, we use threshold cointegration techniques to compare these two metrics of the implied exchange rate with the spot (observed) exchange rate. We find that the implied exchange rates and the spot exchange rate are cointegrated for most of the set of Latin American countries. We also find that for a subset of our sample, the spot exchange rate adjusts to the metric that adds remunerated domestic liabilities. We conclude the remunerated domestic liabilities matter for understanding exchange rate dynamics and explore a simple theoretical setup to better understand the mechanism.

[Publisher][Working Paper]

Estimating Potential Output After Covid: How to Address Unpredecented Macroeconomic Variations (with Daniel Parra) Economic Modelling. Volume 135, June 2024.

Abstract
We examine the importance of adjusting output gap frameworks during large-scale disruptions, with a focus on the COVID-19 pandemic. Such adaptation can be crucial given the impact of such episodes on the reliability of time-series models and the inherent need for stability in output gap methods. We employ a Bayesian Structural Vector Autoregression model, identified through a permanent- transitory decomposition, and enhance it by scaling residuals around the pandemic period. Our analysis, conducted for seven developed economies, suggests that adjusting the model around the pandemic’s onset leads to improved estimates and reduced uncertainty. This approach surpasses traditional filters and other complex models lacking pandemic-timed adjustments. Notably, omitting such adjustments can result in biased and unstable gap estimates, potentially causing rapid gap recoveries post-downturns or increased volatility. Our findings underscore the importance of prompt reassessments of output gap frameworks during unprecedented global events, focusing on their stability and uncertainty.

Abstract

We examine the importance of adjusting output gap frameworks during large-scale disruptions, with a focus on the COVID-19 pandemic. Such adaptation can be crucial given the impact of such episodes on the reliability of time-series models and the inherent need for stability in output gap methods. We employ a Bayesian Structural Vector Autoregression model, identified through a permanent- transitory decomposition, and enhance it by scaling residuals around the pandemic period. Our analysis, conducted for seven developed economies, suggests that adjusting the model around the pandemic’s onset leads to improved estimates and reduced uncertainty. This approach surpasses traditional filters and other complex models lacking pandemic-timed adjustments. Notably, omitting such adjustments can result in biased and unstable gap estimates, potentially causing rapid gap recoveries post-downturns or increased volatility. Our findings underscore the importance of prompt reassessments of output gap frameworks during unprecedented global events, focusing on their stability and uncertainty.

[Publisher][Working Paper]

Pre-Ph.D.

The Effect of Monetary Policy on Commodity Prices: Disentangling the Evidence for Individual Prices. (with Carolina Arteaga and Jair Ojeda) Economics Research International. Vol. 2014, Article ID 649734.

Abstract
In this paper we study the effect of monetary policy shocks on commodity prices. While most of the literature has found that expansionary shocks have a positive effect on aggregate price indices, we study the effect on individual prices of a sample of four commodities. This set of commodity prices is essential to understand the dynamics of the balance of payments in Colombia. The analysis is based on structural VAR models, we identify monetary policy shocks following [Kim, 1999, 2003] upon quarterly data for commodity prices and their fundamentals for the period 1980q1 to 2010q3. Our results show that commodity prices overshoot their long run equilibrium in response to a contractionary shock in the US monetary policy and, in contrast with literature, the response of the individual prices considered is stronger than what has been found in aggregate indices. Additionally, it is found that the monetary policy explains a substantial share of the fluctuations in prices.

Abstract

In this paper we study the effect of monetary policy shocks on commodity prices. While most of the literature has found that expansionary shocks have a positive effect on aggregate price indices, we study the effect on individual prices of a sample of four commodities. This set of commodity prices is essential to understand the dynamics of the balance of payments in Colombia. The analysis is based on structural VAR models, we identify monetary policy shocks following [Kim, 1999, 2003] upon quarterly data for commodity prices and their fundamentals for the period 1980q1 to 2010q3. Our results show that commodity prices overshoot their long run equilibrium in response to a contractionary shock in the US monetary policy and, in contrast with literature, the response of the individual prices considered is stronger than what has been found in aggregate indices. Additionally, it is found that the monetary policy explains a substantial share of the fluctuations in prices.

[Publisher][Working Paper]

Are the Real Exchange Rate Dynamics Explained by its Fundamentals? (in spanish), (with Carolina Arteaga and Jair Ojeda) Ensayos Sobre Política Económica (ESPE). Vol. 31, No. 72, December.

Abstract
In this work, we study the behavior of the real exchange rate (RER) of Colombia, with the help of a co-integration model that takes into account the interaction between the RER and a group macroeconomic determining factors, using quarterly data from the period 1994-2012. These fundamentals include a new relative productivity indicator that enables us to estimate the impact of the Balassa-Samuelson effect on the RER of Colombia. This methodology helps to detect the quarters in which the RER is far from its co-integration relationship and thus, is not explained by the behavior of its fundamentals. The results indicate that the real appreciation observed since the end of 2003 is mainly explained by the increase in terms of trade, and secondly by a proxy of the Balassa-Samuelson effect and due to factors with medium term effects such as the rates differential and risk. Additionally, the dynamics of the RER is mainly explained by the movement in net external assets in the short
term and by government consumption in the medium term</font>

Abstract

In this work, we study the behavior of the real exchange rate (RER) of Colombia, with the help of a co-integration model that takes into account the interaction between the RER and a group macroeconomic determining factors, using quarterly data from the period 1994-2012. These fundamentals include a new relative productivity indicator that enables us to estimate the impact of the Balassa-Samuelson effect on the RER of Colombia. This methodology helps to detect the quarters in which the RER is far from its co-integration relationship and thus, is not explained by the behavior of its fundamentals. The results indicate that the real appreciation observed since the end of 2003 is mainly explained by the increase in terms of trade, and secondly by a proxy of the Balassa-Samuelson effect and due to factors with medium term effects such as the rates differential and risk. Additionally, the dynamics of the RER is mainly explained by the movement in net external assets in the short

term and by government consumption in the medium term</font>

[Publisher][Working Paper]

On the Determinants of Commodity Prices (in spanish), (with Carolina Arteaga and Jair Ojeda) Ensayos Sobre Política Económica (ESPE). Vol. 31, No. 71, December.

Abstract
In this work, an analysis is made of the dynamic response to most relevant basic commodity prices for the evolution of inflation for the consumer in Colombia due to shocks in a group of determining factors. The document is based on structural vector autoregression (VAR) models in which the external shocks are identified by restricting contemporaneous effects between the variables of the system. Quarterly data for the period from the first quarter of 1980 to the third quarter of 2010 was used for the calculation. In accordance with the results, monetary policy, the multilateral exchange rate of the United States of America and the GDP of developed and emerging countries explain a considerable percentage of the prognostic error variance of basic commodity prices. Furthermore, in general terms, the response of the prices due to a monetary policy shock is negative, instantaneous and statistically significant. Shocks to the exchange rate show a negative association with the prices, although not always significant, and in the majority of cases the real activity variables, both in developed countries and in the emerging ones has a positive relationship with the prices considered.

Abstract

In this work, an analysis is made of the dynamic response to most relevant basic commodity prices for the evolution of inflation for the consumer in Colombia due to shocks in a group of determining factors. The document is based on structural vector autoregression (VAR) models in which the external shocks are identified by restricting contemporaneous effects between the variables of the system. Quarterly data for the period from the first quarter of 1980 to the third quarter of 2010 was used for the calculation. In accordance with the results, monetary policy, the multilateral exchange rate of the United States of America and the GDP of developed and emerging countries explain a considerable percentage of the prognostic error variance of basic commodity prices. Furthermore, in general terms, the response of the prices due to a monetary policy shock is negative, instantaneous and statistically significant. Shocks to the exchange rate show a negative association with the prices, although not always significant, and in the majority of cases the real activity variables, both in developed countries and in the emerging ones has a positive relationship with the prices considered.

[Publisher][Working Paper]

Inflation Expectations and Risk Premium Under an Inflation Compensation Method (in spanish), (with Luis F. Melo) El Trimestre Económico, vol. 79, No. 316, Fondo de Cultura Economica. México. October - December.

Abstract
We estimate the Break Even Inflation using the nominal and real government Co-lombian bonds for the period January 2003 to November 2009. This measure is decomposed in inflation expectations and inflation risk premium. The inflation expectations are calculated using a state-space representation of an extended affine term structure model. In order to improve the forecasts, this model incorporates the inflation expectations 12 months ahead of the Colombian Central Bank survey.The results show an inflation expectation downward trend, which may be re-lated to an increasing confidence in monetary policy. This hypothesis is also sup-ported by a decreasing trend in the inflation risk premium for medium and long term maturities (two and five years). Finally, the results indicate that the break even inflation is a good indicator of the inflation expectations for the short term forecast horizon (one year).

Abstract

We estimate the Break Even Inflation using the nominal and real government Co-lombian bonds for the period January 2003 to November 2009. This measure is decomposed in inflation expectations and inflation risk premium. The inflation expectations are calculated using a state-space representation of an extended affine term structure model. In order to improve the forecasts, this model incorporates the inflation expectations 12 months ahead of the Colombian Central Bank survey.The results show an inflation expectation downward trend, which may be re-lated to an increasing confidence in monetary policy. This hypothesis is also sup-ported by a decreasing trend in the inflation risk premium for medium and long term maturities (two and five years). Finally, the results indicate that the break even inflation is a good indicator of the inflation expectations for the short term forecast horizon (one year).

[Publisher][Working Paper]

Financial Regulation and Value at Risk (in spanish), (with Luis F. Melo) Ensayos Sobre Política Económica (ESPE), vol. 29, No. 64.

Abstract
This document analyzes some aspects of Colombian financial regulation related to the Value at Risk (VaR) which is used to measure the market risk. In particular, we study the adequacy of the root rule and the performance evaluation of some alternative backtesting methodologies not considered by the current regulation. In order to analyze this problem, two measures of risk were considered;
VaR, and Conditional VaR (CVaR), using different methodologies of easy implementation (RiskMetrics, ARMA-GARCH, historical simulation, filtered historical simulation and assuming normal i.i.d. returns) for the Colombian nominal exchange rate, the treasury bonds (TES) and the Colombian stock market index in the sample period from January 2003 to March 2010. The results show that for one day forecast horizon the considered methodologies measure properly the VaR. The methods with the best performance are those that model both the mean and the conditional variance. On the other hand, for horizons higher than one day, all methodologies have inadequate performance. In particular, it is found that the root rule does not provide acceptable estimations of the multiperiod VaR. It is important to note, that if the current regulation criteria are considered, some models would be adequate. However, when additional assumptions are taken into account, none of these methodologies is appropriated. </font>

Abstract

This document analyzes some aspects of Colombian financial regulation related to the Value at Risk (VaR) which is used to measure the market risk. In particular, we study the adequacy of the root rule and the performance evaluation of some alternative backtesting methodologies not considered by the current regulation. In order to analyze this problem, two measures of risk were considered;

VaR, and Conditional VaR (CVaR), using different methodologies of easy implementation (RiskMetrics, ARMA-GARCH, historical simulation, filtered historical simulation and assuming normal i.i.d. returns) for the Colombian nominal exchange rate, the treasury bonds (TES) and the Colombian stock market index in the sample period from January 2003 to March 2010. The results show that for one day forecast horizon the considered methodologies measure properly the VaR. The methods with the best performance are those that model both the mean and the conditional variance. On the other hand, for horizons higher than one day, all methodologies have inadequate performance. In particular, it is found that the root rule does not provide acceptable estimations of the multiperiod VaR. It is important to note, that if the current regulation criteria are considered, some models would be adequate. However, when additional assumptions are taken into account, none of these methodologies is appropriated. </font>

[Publisher][Working Paper]

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