Countercyclical Prudential Tools in an Estimated DSGE Model

We develop a DSGE model for a small, open economy with a banking sector and endogenous default in order to perform a realistic assessment of macroprudential tools: countercyclical capital buffer (CCB) and dynamic provisions... [ view full abstract ]

We develop a DSGE model for a small, open economy with a banking sector and endogenous default in order to perform a realistic assessment of macroprudential tools: countercyclical capital buffer (CCB) and dynamic provisions (DP). The model is estimated with data for Uruguay, where dynamic provisioning is in place since early 2000s. We find that (i) the source of the shock affecting the financial system matters, to select the appropriate indicator variable under the CCB rule, and to calibrate the size of the DP. Given a positive external shock, CCB (ii) generates buffers without major real effects; (iii) GDP as an indicator variable has quicker and stronger effects over bank capital; and (iv) the ratio of credit to GDP decreases, which discourages its use as an indicator variable. DP (v) generates buffers with real effects, and (vi) seems to outperform the CCB in terms of smoothing the cycle.