Macroprudential policies, the long-term interest rate and the exchange rate

The Bernanke-Blinder closed economy model suggests that macroprudential policies aimed at bank lending will affect the domestic long-term interest rate. In an open economy, domestic shocks to long-term rates are likely to influence capital flows and the exchange rate. Currency movements feed back into domestic credit through several channels, which will be influenced by balance sheet positions and not only by income flows. Macroprudential policies aimed at domestic credit and at foreign currency borrowing may be the best option open to small countries facing very low global interest rates and risky domestic credit expansion.

JEL classification: E43, E58, F41, G28

Keywords: Bernanke-Blinder model, capital flows, interest rate policy, macroprudential policy