Can macroprudential policies mitigate pressures from capital inflows on real exchange rates? Empirical evidence from emerging markets

Can macroprudential policies (MaPs) mitigate the pressures from capital inflows on real exchange rates in emerging markets? We investigate this question empirically for a large panel of emerging markets, factoring in the heterogeneity of capital inflows. Exploiting a comprehensive dataset on MaPs for a panel of 85 countries spanning the time-period 2000-2017, we empirically examine the association between different types of gross capital flows and real effective exchange rates (REER) and assess whether there is a role for MaPs in influencing that relationship. We find that the imposition of MaPs helps counter REER appreciation only when it results from higher gross portfolio debt inflows. In other words, the moderating impact of MaPs on REER varies by the type of capital flows. We also show that these results hold only for countries with high degrees of financial development, possibly because MaPs work primarily via the financial system and hence there needs to be a reasonable level of financial development for them to be effective.