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Macro Prudential Supervision in the Open Economy, and the Role of Central Banks in Emerging Markets

Economic Research Institute (82-2-759-5071) 2010.02.04 4116

In this paper we explore lessons from the current global liquidity
crisis pertaining to the prudential supervision role of central bank in
an open economy. The crisis validates the need for external debt
management policy in emerging markets. Hoarding international
reserves (IR) is a potent self-insurance mechanism. However, it is
associated with relatively high costs and is also less efficient in
absence of assertive external debt management policies. In the
presence of firesale externalities associated with deleveraging, optimal
external borrowing-tax-cum-IRhoarding-subsidy reduces the cost as
well as the scale of hoarding IR.

1. Introduction
2. Prudential supervision, capital inflows, and deleveraging Vulnerabilities
2.1 The Fire Sale deleveraging externality and the case for a Pigovian tax-cum-subsidy scheme
3. The recent experience