Commodity Prices Bank Balance Sheets and Macropr - 2022 - Latin American Journa

Latin American Journal of Central Banking 3 (2022) 100052
Contents lists available at ScienceDirect
Latin American Journal of Central Banking

journal homepage: www.elsevier.com/locate/latcb
Commodity prices, bank balance sheets and macroprudential

policies in small open economies☆
Alfredo Villca1
Departamento de Economía, Universidad EAFIT, Colombia
a r t i c l e i n f o a b s t r a c t
JEL classification: How important are liability dollarization in the transmission of commodity shocks on business
E32 cycles? To address this question, we developed a small open economy DSGE model with a bank-
E44 ing sector and financial friction. The banks collect funds in the international capital markets in
F32
the form of foreign debt, which is denominated in dollars. Faced with a commodity shock, the
F41
results suggest that the presence of liability dollarization generates a greater response output,
Keywords: compared to the model that ignores this financial mechanism. In fact, after simulating a series of
Business cycles shocks in each period, bank balance sheets amplify expansions and deepen economic recessions.
Commodity prices Thus, the volatility of business cycles is strongly affected by the presence of liability dollarization.
Small open economy However, the application of countercyclical macroprudential policies, based on Basel III capital
Bank balance sheets requirements, absorbs the impacts of commodity shocks. In addition, this type of policy allows
Liability dollarization
greater gains in social welfare. In summary, it can be pointed out that the bank balance sheets
Financial frictions
are quantitatively important because they provide information to understand macroeconomic
fluctuations.
1. Introduction
The dollarization of external liabilities plays an important role explaining the links between commodity prices and business cycles
in emerging countries. When banks external debt is denominated in dollars, a rise in commodity prices generates an appreciation
of the exchange rate, increases the value of debt and credit, therefore, bank balance sheets expand2 . This dynamic has important
consequences for the real economy, because firms balance sheets also expand through an increase in investment and credit-financed
capital and, taking into account production technology, the output undergoes an expansive phase. On the other hand, a collapse in
commodity prices generates a deterioration of bank balance sheets, because they face a monetary mismatch. This negative effect
is impact to the real economy, as firms face higher financing costs. In any case, the countercyclical macroprudential policy allows
cushioning the effects of commodity price shocks.
A broad spectrum of literature has studied the effects of commodity prices and terms of trade shocks on business cycles.
The typical approach suggests that real markets and trade flows act as a transmission channel (See, for example, Broda, 2004;
☆
This paper was the product of the preparation of Ph.D. dissertation and was one of the winners of the Rodrigo Gómez Award for Central Banking
from the Centro de Estudios Monetarios Latinoamericanos (CEMLA) 2021.
E-mail address: avillca@eafit.edu.co
1 I am grateful for comments from Alejandro Torres García, Oscar Valencia Arana, Jesús Bejarano Rojas, and the anonymous referees who helped
improve the paper

2
This balance sheet shows that assets should equal liabilities plus equity and its monitoring is important for macroprudential policy, which is a
tool of financial stability bodies in which Central Banks participate.
https://doi.org/10.1016/j.latcb.2022.100052
Received 3 February 2022; Accepted 9 March 2022
Available online 1 April 2022
2666-1438/© 2022 The Author(s). Published by Elsevier B.V. on behalf of Center for Latin American Monetary Studies. This is an open access
article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/)
A. Villca Latin American Journal of Central Banking 3 (2022) 100052
Drechsel and Tenreyro, 2018; Fernández et al., 2018; 2017; Kose, 2002; Mendoza, 1995; Roch, 2019; Schmitt-Grohé and Uribe,
2018; Shousha, 2016; Zeev et al., 2017). This is because an increase in commodity prices generates an increase in raw material
exports. This affects positively the trade balance, aggregate demand and, as a result, output growth3 .
While this transmission channel has been extensively explored, there may be room for the study of an additional mechanism.
Financial markets and international capital flows may provide additional information to understand the relationship between com-
modity prices and business cycles. The papers of Abraham et al. (2020); Aldasoro and Ehlers (2018); Durdu et al. (2019); Eren and
Malamud (2021); Georgiadis and Zhu (2020) suggest that the debt acquired by emerging economy banks in international markets
has increased over time and, consequently, the reliance on this debt in foreign currency, in particular the dollar, has also increased.
Similarly, the work of Agarwal et al. (2020) and Eberhardt and Presbitero (2021), based on econometric regressions, supports the
idea that commodity prices have important effects on the behavior of the financial system. In fact, the classical literature in this line
has put the “original sin” hypothesis, a situation in which agents in small economies cannot use the domestic currency to transact
in international markets (See, for example, Calvo and Reinhart, 2002; Eichengreen and Hausmann, 1999; Eichengreen et al., 2003;
Gavin and Hausmann, 1996).
From a theoretical point of view, recent research has contributed significantly in formalizing and rationalizing the behavior of
banks or financial intermediaries in general equilibrium frameworks in both closed and open economies (See, for example, Aoki et al.,
2016; Gertler and Karadi, 2011; Gertler and Kiyotaki, 2010; Kitano and Takaku, 2017; 2020; Mimir and Sunel, 2019; Nispi Landi,
2017)4 . However, all cases concentrate on studying the role of monetary policy or, alternatively, capital controls considering inter-
national interest rate shocks, omitting, among others, commodity price shocks. The latter is important because it has been stressed
that the effects of international interest rates lose importance when commodity prices are considered (Shousha, 2016). Furthermore,
it has been mentioned that commodity price shocks are much more important in explaining business cycles in emerging countries
(Fernández et al., 2018).
This paper investigates and quantifies the role of the dollarization of external bank liabilities in the transmission of commodity
price shocks over business cycles. To address this question we combine empirical and theoretical methods. First, we collect data on a
set of relevant variables for six Latin American countries during 2000:Q1–2018:Q3. With these data we formulate a Structural Vector
Autoregressive (SVAR) model and estimate this model for each country. This is important because it allows us to establish the stylized
facts and empirically underpins the theoretical formalization of the transmission mechanisms and dynamics of the economy. Second,
we develop a Dynamic Stochastic General Equilibrium (DSGE) model for a small open economy. The core of the model is based on
Fernández et al. (2018) which explicitly incorporate a commodity endowment sector in the setup established by Correia et al. (1995);
Mendoza (1991) and Schmitt-Grohé and Uribe (2003). We extend this framework in three ways. (i) We incorporate a banking sector
following the spirit of Gertler and Karadi (2011), but assuming that these agents raise funds, in addition to the domestic market,
in international capital markets. (ii) We include the costly verification problem that banks face with firms and do so in the manner
of Bernanke et al. (1999). (iii) We explicitly show the relationship between commodity prices and the real exchange rate. This
relationship is key in our model, because it allows us to capture the effects of commodity price shocks on bank balance sheets.
There are three types of financial frictions, which arise from the existence of asymmetric information problems faced by banks. For
simplicity, the first friction (households-banks) is modeled as a moral hazard problem, the second (firms-banks) as a Costly State
Verification (CSV) problem and the third is assumed to be a parameter, which represents the fraction between the international and
domestic risk premium. Our model is richer than any other of its kind because it allows us to experiment with different types of
policies, among which macroprudential policy stands out.
The results, according to the SVAR model, suggest that commodity prices have positive effects on business cycles through balance
sheets and, under certain conditions, this financial mechanism amplifies the response of output with respect to its trend. At the
time of impact, output reacts by up to 0.98% in the presence of balance sheets, while it reacts by up to 0.67% when this financial
mechanism is ignored, therefore, the gap to be 0.31%. It is this statistical result that is intended to be captured and rationalized in a
DSGE framework.
Thus, the results of the DSGE model indicate that a growth in international commodity markets allows domestic banks to access
greater external resources to finance credit growth. This growth allows an increase in the flow of investment and the stock of capital on
the part of companies. As a result, the economy moves into its expansion phase, output expands up to 1.5% in the presence of liability
dollarization compared to 1.1% in the absence of this channel. These figures represent the amplifying effect of the dollarization of
external liabilities by 0.4%. To get a clearer, a Monte Carlo simulation is performed, the results show that the presence of liability
dollarization amplifies expansions and deepens economic recessions. In fact, quantifying the 1st and 5th percentiles - recession phases
- and the 95th and 99th percentiles - expansion phases - show an amplification of the peaks and a deepening of the troughs. The
probability distributions of the simulated series also confirm this finding.
The existence of the amplifying effect of the dollarization of external liabilities raises the question of whether or not countercyclical
macroprudential policies can dampen the effects of these shocks. We conducted this experiment taking into account the capital
requirements established in the Basel II and III accords. According to the rules, Basel II capital requirements are constant over time.
3
There is no consensus on the quantitative importance of commodity shocks on cycles. While a large majority of studies suggest that more
than 30 percent of the variance of output is explained by commodity shocks, others suggest that this figure is only 10 percent (See, for example,
Schmitt-Grohé and Uribe, 2018).
4
Theoretical formalization in this body of literature has inspiration in the current that emphasizes the role of “Balance Sheets” in economics, among
them Céspedes et al. (2004) and Gertler et al. (2007), and the role of financial frictions, such as Kiyotaki and Moore (1997) and Bernanke et al. (1999).
2
However, for our purposes we consider this requirement to be time-varying and a function of the current state of the economy,
determined by commodity prices, this is interesting because it allows us to study different policy regimes, including a countercyclical
policy, and supports the idea of making regulation more flexible. Nevertheless, Basel III is variable and explicitly considers the phases
of the economic and financial cycles. The results indicate that countercyclical policies cushion the impacts of commodity shocks,
because they curb excessive credit and output growth, but also allow for greater social welfare gains expressed in terms of equivalent
consumption
The remainder of the paper is organized as follows. Section 2 establishes the empirical facts. Section 3 develops the model and
explains the behavior of the agents. Section 4 performs the quantitative exercises. Section 5 reports the results of the macroprudential
policy experiment. In Section 6 we confront the model with the data and, finally, we conclude the paper with some important
implications.
2. Empirical facts
2.1. Commodity prices and bank balance sheets
Data is collected for six Latin American countries during 2000:Q1–2018:Q3. These countries are; Argentina, Brazil, Chile, Colom-
bia, Mexico, and Peru, they were chosen for three important reasons. Firstly, they are exporters of commodities, including agricultural,
mineral, and energy. Secondly, these countries account for more than 80% of the output Latin America. At the same time, they have
similar economic and financial structures, which is attractive for comparison purposes.
To examine the relationship between commodity prices and bank balance sheets we consider two key variables; assets (credit) and
liabilities (external debt). Using these two series, we then extract the log deviations from the trend using Hodrick–Prescott (HP) filter
(𝜆 = 1600). We correlate these series with deviations from the trend in commodity prices. It should be noted that the prices of raw
materials are common in all countries and were obtained from the World Bank (WB). The alternative would be to use specific prices
for each country that was compiled by Gruss and Kebhaj (2019) available from the International Monetary Fund (IMF). Even so, both
types of price indices have similar trajectories. Fig. 1 shows a co-movement between bank assets with commodity prices (average
correlation 0.65), this means that increases in bank assets are associated with increases in commodity prices and, vice versa, falls
in assets are related to falls in commodity prices. These correlation coefficients are mostly statistically significant at 5%. Fig. 2 also
shows a pattern of co-movement between bank liabilities with commodity prices, as in the previous case they are also statistically
significant at 5%. These two observations indicate that commodity shocks can have potential effects on bank balance sheets and this,
in turn, on the behavior of the financial system and the real economy. To have a more formal idea about the role of bank balance
sheets in the economy, an empirical model is estimated below.
Fig. 1. Credit and commodity prices.
3
Fig. 2. Bank external debt and commodity prices.
2.2. Empirical model
To formally explore the effects of commodity prices in the economy, taking into account the elements of bank balance sheets,
we specify a Structural Vector Autoregressive (SVAR) model. For this we follow the suggestions of the literature (See, for example,
Caldara et al., 2019; Drechsel and Tenreyro, 2018; Fernández et al., 2017; Schmitt-Grohé and Uribe, 2018; Zeev et al., 2017)
A0 x𝑡 = A1 x𝑡−1 + Bu𝑡 .
where the vector x𝑡 contains the short-term components of the following variables and in that order; commodity prices (𝑝̂𝑐𝑜𝑚 𝑡 ), real
exchange rate (𝑒̂𝑡 ), country risk-EMBIG - (̂ ̂𝑡 ), internal credit (𝑐̂𝑡 ) and output (𝑦̂𝑡 ).
𝑠𝑡 ), trade balance to GDP (𝑡𝑏𝑡 ), bank external debt (𝑒𝑏𝑑
The short term component is obtained using the HP filter. The trade balance corresponds to a deviation of the output and not of the
trend (See, for example, Fernández et al., 2017; Schmitt-Grohé and Uribe, 2018; Uribe and Yue, 2006). The selection and order of the
variables are based on the literature that emphasizes the role of the dollarization of external liabilities (See, for example, Céspedes
et al., 2004; Eichengreen and Hausmann, 1999; Eichengreen et al., 2003; Gertler et al., 2007).
To estimate the model we write in its reduced form, x𝑡 = Ax𝑡−1 + 𝝐 𝑡 , where A0 𝝐 𝑡 = Bu𝑡 and A = A−1 0
A1 . The identification assump-
tion considers that the model is recursive. This implies that A0 [𝑎𝑖𝑗 ] is typically a lower triangular matrix, that is 𝑎𝑖𝑗 ≠ 0 if 𝑖 > 𝑗, 𝑎𝑖𝑗 = 0
if 𝑖 < 𝑗 and 𝑎𝑖𝑗 = 1 if 𝑖 = 𝑗. It is a story about a certain endogenous variable explained by those who are “ up ” in the system. One
aspect to highlight is that emerging economies are price takers, which 𝑝𝑐𝑜𝑚 𝑡 behaves as a first-order autoregressive process. Thus, the
first row of the A1 array is all zeros, except for the first element, which captures the persistence of prices.
The arrays A0 , A1 and B are estimated for each country. The results are seen in Fig. 3 and suggest that a commodity shock,
equivalent to a deviation of 8% from the trend, generates positive effects on the behavior of the economy. This pattern is observed
in all countries, specifically, the surprise increase in commodity prices generates a drop in the exchange rate and country risk, which
explains the increase in external debt and domestic credit. This means that the financial system is positively expanding. The real
economy is also expanding positively, the output reacts up to 0.98% on average at the moment of impact.
Next, to capture the role of bank balance sheets, we impose simple constraints on the model, the restrictions are imposed on the
A0 and A1 arrays. First, we assume that the lags of credit 𝑐̂𝑡 and bank external debt 𝑒𝑑𝑏 ̂𝑡 do not affect the rest of the variables. This
means that the fifth and sixth columns of the array A1 are zeros, however both 𝑐̂𝑡 and 𝑒𝑑𝑏 ̂𝑡 are explained by the system. Second, we
̂𝑡 do not respond to commodity shocks, therefore elements 𝑖, 𝑗 = 5, 1 and 𝑖, 𝑗 = 6, 1 of the array A0 are equal to
assume that 𝑐̂𝑡 and 𝑒𝑑𝑏
zero. We label this model as “SVAR without balance sheet” while the previous model we label as “SVAR with balance sheet”.
Taking into account the averages of the impulse response, as representative of all the countries, our results are surprising. Bank
balance sheets play an important role in explaining the deviation of the output concerning the long-term trend. In Fig. 4 the impulse
response functions are observed (blue dotted line), an accelerating effect of bank balance sheets on the economy is observed. That
is to say, given the same commodity price shock (8%) in both models, the dynamics of the variables - with qualitatively similar
movements- show significant differences in quantitative terms. The output reacts up to 0.98% on the SVAR with balance sheets and
4
Fig. 3. Latin America: impulse-response to commodity shocks. Note: The solid impulse response line represents a simple average. Although the
median, as suggested by Schmitt-Grohé and Uribe (2018), is very close to the simple average.
reacts up to 0.67% on the SVAR model without balance sheets, which means a gap of 0.31%. This finding implies that the financial
element constitutes a transmission channel on business cycles, in addition to acting as an accelerating variable.
3. Model
The model has five types of agents; households, banks, goods-producing firms, capital-producing firms and the external sector.
Each agent solves a maximization problem, except the external sector since its behavior is assumed exogenous. Within the household,
there are two types of members; one fraction 𝑓 are bankers and the other fraction 1 − 𝑓 are workers. Bankers generate dividends
and return them to the home, while workers do so with their wages, over time, an agent can switch between the two occupations,
a banker remains a banker in the next period with probability 𝜃, while, (1 − 𝜃)𝑓 bankers leave the financial industry and become
workers. A similar number of workers randomly become bankers, so that the relative proportion of each agent is constant.
Generally speaking, the economy works as follows. Households keep deposits in the banking, rent jobs to firms that produce
goods, and export raw materials to the external sector. In counterpart, they receive income from their deposits and wages for their
jobs, with which they purchase consumer goods and accumulate assets for the next period. Consumer goods are assumed to be a
basket made up of domestic goods and foreign goods. For their part, banks raise funds through deposits, external debt and equity
to offer loans to firms in the credit markets. In return, they must pay costs for these financial operations and receive loan returns.
Goods-producing firms finance the production of goods by borrowing from banks, renting labor from households, and buying capital
from capital-producing firms. In return, they must pay the costs of the credits and must pay the costs of the productive factors. The
fourth agent, capital producing firms, are specialists in producing and repairing capital goods that they sell to the goods producing
firms. To produce this capital, it is assumed that these companies acquire domestic investment goods and foreign investment goods.
Finally, the rest of the world demands raw materials and other consumer goods exogenously and they determine prices; such as
interest rates and commodity prices.
5
Fig. 4. SVAR model, with balance sheet and without balance sheet.Note: The impulse response represent a simple average of the estimated IRFs for
each country in the with balance sheet model and without balance sheet.
The central characteristic of the configuration of our model is that it has different types of financial frictions. Specifically, banks
face friction with households and with the rest of the world, while firms do so with banks. These frictions arise from the existence of
asymmetric information and moral hazard problems, which implies that banks have incentives to divert both domestic and foreign
funds for other purposes. Similarly, firms have incentives to divert loans for purposes other than their investment projects. To solve
this problem, incentive restrictions are imposed, which imply that the value of the banks must be greater than or equal to the costs
of diverting funds. In such a way that the offer of credits that they carry out are limited by their own capital. However, to solve the
problem of asymmetric information between banks and firms, an optimal contract type problem is formulated and solved in each
period since frictions are endogenous in the model.
3.1. Households
First, the household is faced with a basket of consumer goods, made up of; home goods, 𝐶𝐻,𝑡 , and foreign goods, 𝐶𝐹 ,𝑡 . We denote
this basket by 𝐶𝑡 = 𝐶(𝐶𝐻,𝑡 , 𝐶𝐹 ,𝑡 )5 and is assumed to be captured by an index with constant elasticity of substitution (CES), as in Galí
and Monacelli (2005) and Gertler et al. (2007).
[ 𝜂 −1 𝜂 −1
] 𝜂𝑐
1 𝑐 1 𝑐 𝜂𝑐 −1
𝜂 𝜂 𝜂
𝐶𝑡 = (1 − 𝛾𝑐 ) 𝜂𝑐 𝐶𝐻,𝑡𝑐 + 𝛾𝑐 𝑐 𝐶𝐹 ,𝑡𝑐 , (1)
where 𝛾𝑐 ∈ (0, 1) is the share of imported consumer goods in total consumer goods and 𝜂𝑐 > 0 is the elasticity of substitution between
home consumption and imported consumption. The intratemporal problem is to minimize expenses 𝑝𝑡 𝐶𝑡 = 𝑝𝐻,𝑡 𝐶𝐻,𝑡 + 𝐶𝐹 ,𝑡 and, as in
5
In the rest of the document the subscript 𝐻 will be used to denote the domestic economy and 𝐹 a the foreign economy, unless stated otherwise.
6
Fernández et al. (2018), the prices of total consumer goods 𝑝𝑡 and the prices of domestic consumer goods 𝑝𝐻,𝑡 are expressed in relative
terms, whose numerary is 𝑝𝐹 ,𝑡 . From the first-order conditions this problem, the demand functions for consumer goods are
( )
𝑝𝐻,𝑡 −𝜂𝑐
𝐶𝐻,𝑡 = (1 − 𝛾𝑐 ) 𝐶𝑡 , (2)
𝑝𝑡
and
( )−𝜂𝑐
1
𝐶𝐹 ,𝑡 = 𝛾𝑐 𝐶𝑡 . (3)
𝑝𝑡
Using these functions and replacing them in the objective function, the Consumer Price Index (CPI) is obtained, expressed in relative
terms
[ ] 1
1−𝜂 1−𝜂𝑐
𝑝𝑡 = (1 − 𝛾𝑐 )𝑝𝐻,𝑡 𝑐 + 𝛾𝑐 (1)1−𝜂𝑐 . (4)
Second, the home makes consumption, work and savings decisions. Over an infinite time horizon, the household aims to maximize
the expected present value of the utility. The intertemporal problem is
∑
∞
max∞ 𝔼𝑡 𝛽 𝑖 𝑈 (𝐶𝑡+𝑖 , 𝐿𝑡+𝑖 ), (5)
{𝐶𝑡 ,𝐿𝑡 }𝑡=0
𝑖=0
where 𝛽 ∈ (0, 1) is the discount factor and 𝐿𝑡 is the working hours. The specific utility function is given according to
Greenwood et al. (1988). This function is chosen to prevent job offer decisions from being affected by the income effect
( )1−𝜎
⎡ 𝐿1+𝜑 ⎤
1 ⎢
𝑈 (𝐶𝑡 , 𝐿𝑡 ) = 𝐶𝑡 − 𝜓 𝐿 𝑡 − 1⎥,
1−𝜎⎢ 1+𝜑 ⎥
⎣ ⎦
with 𝜎 is the constant relative risk aversion coefficient, 𝜑 is the inverse of the Frisch elasticity of labor supply, and 𝜓 𝐿 is a scale
parameter. Problem (5) is solved taking into budget constraint
𝑝𝑡 𝐶𝑡 + 𝐷𝑡+1 = 𝑤𝑡 𝐿𝑡 + 𝑅𝑡 𝐷𝑡 + Π𝑡 . (6)
The left side of the restriction represents the destination of the income, its components are; consumption 𝑝𝑡 𝐶𝑡 and asset accumulation
𝐷𝑡+1 . While the right side represents the sources of income that are given by; real salary 𝑤𝑡 𝐿𝑡 , return on assets 𝑅𝑡 𝐷𝑡 and profits
obtained from the firms, banks and sector commodity, Π𝑡 = Π𝑓𝑡 + Π𝑏𝑡 + Π𝐶𝑜 𝑡 . The equilibrium conditions are defined by:
( )
𝑝
1 = 𝛽𝔼𝑡 Λ𝑡,𝑡+1 𝑅𝑡+1 𝑡 , (7)
𝑝𝑡+1
𝑤𝑡 = 𝜓 𝐿 𝑝𝑡 𝐿𝜑𝑡 , (8)
and
( )−𝜎
𝜓 𝐿 1+𝜑
𝜚𝑡 = 𝐶𝑡 − 𝐿𝑡 . (9)
1+𝜑
𝜚𝑡+1
where Λ𝑡,𝑡+1 ≡ 𝛽 is the stochastic discount factor and 𝜚𝑡 is the marginal utility of consumption.
𝜚𝑡
3.2. Financial intermediaries
There is a continuum of banks indexed in 𝑗 ∈ [0, 1] that channel resources from savers to firms that produce goods. In period 𝑡
the bank 𝑗 grants credits, 𝑆𝑗,𝑡 , to the producers of goods at a price 𝑄𝑡 , these credits are financed by; net worth 𝑁𝑗,𝑡 , deposits 𝐷𝑗,𝑡 and
external debt 𝑒𝑡 𝐵𝑗,𝑡 denominated in dollars, 𝑒𝑡 is the real exchange rate. Thus, the banks balance sheet is defined by
𝑄𝑡 𝑆𝑗,𝑡 = 𝑁𝑗,𝑡 + 𝐷𝑗,𝑡 + 𝑒𝑡 𝐵𝑗𝑡 . (10)
The net worth of honest banks that manage to stay in the financial industry is given by the difference between income and costs. At
the beginning of the period 𝑡 + 1, income is the returns on loans, denoted by Γ(𝜔𝑡+1 )𝑅𝐾,𝑡+1 𝑄𝑡 𝑆𝑗,𝑡 , while the costs are given by interest
on deposits, 𝑅𝑡+1 𝐷𝑡+1 , with 𝑅𝑡 the interest rate on deposits, and interest on external debt, 𝑒𝑡 𝑅𝐵,𝑡+1 𝐵𝑗,𝑡 , with 𝑅𝐵,𝑡 the interest rate
charged by international investors. Consequently, net worth is defined by
𝑁𝑗,𝑡+1 = Γ(𝜔𝑡+1 )𝑅𝐾,𝑡+1 𝑄𝑡 𝑆𝑗,𝑡 − 𝑅𝑡+1 𝐷𝑗,𝑡 − 𝑒𝑡 𝑅𝐵,𝑡+1 𝐵𝑗𝑡 , (11)
where
𝜔𝑡+1
Γ(𝜔𝑡+1 ) = (1 − 𝜇𝑏 ) 𝜔𝑓 (𝜔)𝑑𝜔 + [1 − 𝐹 (𝜔𝑡+1 )]𝜔𝑡+1
∫0
7
represents the marginal profits of banks and weights the idiosyncratic factors of firms, captured by 𝜔𝑡 . The objective of banks is to
maximize the net expected value of equity
∑
∞
𝑉𝑗,𝑡 = max 𝔼𝑡 (1 − 𝜃)𝜃 𝑖 Λ𝑡,𝑡+𝑖+1 𝑁𝑗,𝑡+𝑖+1 , (12)
{𝑆𝑡 ,𝐷𝑡 ,𝐵𝑡 }
𝑖=0
where 𝜃 is the probability of survival in the financial industry.

Dishonest banks can alienate/divert available funds, they have two inclusive alternatives; divert local funds and external funds. To
motivate a limit on their ability to do so, a moral hazard problem (Gertler and Karadi, 2011; Gertler and Kiyotaki, 2010) is presented.
First, bankers may choose to divert a Θ fraction of funds raised in the domestic market. Second, a fraction Θ∗ of the funds they obtain
in international markets can also be the object of disposal. As in Kitano and Takaku (2020) we assume that assets financed with
external debt are easier to divert than those financed with deposits and equity, that is Θ∗ > Θ. For lenders, both local and foreign, to
be willing to supply funds to the banker, it must be satisfied that the value of banks, 𝑉𝑗,𝑡 (𝑆𝑗,𝑡 , 𝐷𝑗,𝑡 , 𝐵𝑗,𝑡 ), must be greater than or equal
to the benefit of diverting funds, Θ(𝐷𝑗,𝑡 + 𝑁𝑗,𝑡 ) + Θ∗ 𝑒𝑡 𝐵𝑗,𝑡 . Mathematically, the following incentive constraint must be met
𝑉𝑗,𝑡 ≥ Θ(𝐷𝑗,𝑡 + 𝑁𝑗,𝑡 ) + Θ∗ 𝑒𝑡 𝐵𝑗,𝑡 .
We can assume that Θ∗ is equal to the fraction of diverting local funds plus a proportion of the degree of international financial
friction 𝜗, 𝜗 > 0. That is, Θ∗ = (1 + 𝜗)Θ. With this assumption, the previous restriction can be written
𝑉𝑗,𝑡 ≥ Θ(𝑄𝑡 𝑆𝑗𝑡 + 𝜗𝑒𝑡 𝐵𝑗𝑡 ). (13)
Given that the “deviable” amount of funds financed with external debt should not be greater than the total amount of it, then an
1
upper limit of 𝜗 can be deduced, which is given by the inequality, 0 < 𝜗 ≤ − 1.
Θ
The value of banks at the beginning of period 𝑡 satisfies the following Bellman equation
[ ]
𝑉𝑗,𝑡−1 (𝑆𝑗,𝑡−1 , 𝐵𝑗,𝑡−1 , 𝐷𝑗,𝑡−1 ) = 𝔼𝑡−1 Λ𝑡−1,𝑡 (1 − 𝜃)𝑁𝑗,𝑡 + 𝜃 max 𝑉𝑗,𝑡 (𝑆𝑗,𝑡 , 𝐵𝑗,𝑡 , 𝐷𝑗,𝑡 ) (14)
To solve this problem, we use the method of undeterminate coefficients, for this, we propose the following hypothesis.
Hypothesis 1. Let 𝑉𝑗,𝑡 (𝑆𝑗,𝑡 , 𝐵𝑗,𝑡 , 𝐷𝑗,𝑡 ) ∶ ℝ3,+ → ℝ a linear function of 𝑆𝑗,𝑡 , 𝐷𝑗,𝑡 and 𝐵𝑗,𝑡 , then
𝑉𝑗,𝑡 (𝑆𝑗,𝑡 , 𝐵𝑗,𝑡 , 𝐷𝑗,𝑡 ) = 𝜂𝑠,𝑡 𝑆𝑗,𝑡 − 𝜂𝑏,𝑡 𝐵𝑗,𝑡 − 𝜂𝑡 𝐷𝑗,𝑡 , (15)
where 𝜂𝑠,𝑡 , 𝜂𝑏,𝑡 and 𝜂𝑡 are indeterminate dynamic coefficients. This linearity implies that the heterogeneity of the banks does not affect
the aggregate dynamics of the financial system.
Using this hypothesis and the Lagrange multiplier, the solution for max 𝑉𝑗,𝑡 (𝑆𝑗,𝑡 , 𝐵𝑗,𝑡 , 𝐷𝑗,𝑡 ) can be stated in the following statement.
Proposition 1. When the incentive constraint is binding, the bank’s loan supply 𝑗 is given by the difference between the share of net worth
and the share of external debt
𝑄𝑡 𝑆𝑗,𝑡 + 𝜗𝑒𝑡 𝐵𝑗,𝑡 = 𝜙𝑡 𝑁𝑗,𝑡 , (16)
where 𝜙 represents bank leverage given by

𝜂𝑡
𝜙𝑡 = , (17)
Θ − 𝜈𝑡
also, 𝜈𝑡 represents the expected marginal profit per unit of assets. This term is related to the degree of sensitivity of the bank’s value to foreign
debt changes and the degree of international friction, that is; 𝜈𝑡 = 𝜗−1 𝜇𝑡 . For its part, 𝜂𝑡 represents the expected discounted value of having an
additional unit of equity.
Proof. See Appendix B. □
The endogenous constraint ensures that bank leverage is always equal to 𝜙, which decreases as the fraction of assets that are
diverted increases. In the particular case where 𝜗 = 0, that is Θ∗ = Θ, it means that international funds have the same degree of
friction as local funds. Then 𝑄𝑡 𝑆𝑗,𝑡 = 𝜙𝑡 𝑁𝑗,𝑡 , which corresponds to the solution of Gertler and Karadi (2011) in the closed economy
case. The solution (16) is key in our model, because it is at the heart of the financial accelerator principle, this relationship shows
an inverse movement between the supply of credit and the real exchange rate. Therefore, an increase of 𝑒𝑡 has a negative effect on
banks’ assets, which is reinforced in subsequent periods by a fall in the prices of resale assets and a deterioration in bank capital.
Next, we verify Hypothesis 1 regarding the form of the value function.
Proposition 2. For Hypothesis 1 to be correct, the excess value of bank assets, 𝜈𝑡 , the costs associated with external debt, 𝜇𝑡 , and the costs
of deposits, 𝜂𝑡 , have to satisfy the following:
( )
𝜈𝑡 = 𝔼𝑡 Λ𝑡,𝑡+1 Ω𝑡+1 Γ(𝜔𝑡+1 )𝑅𝐾,𝑡+1 − 𝑅𝑡+1 , (18)
𝜇𝑡 = 𝔼𝑡 Λ𝑡,𝑡+1 Ω𝑡+1 (𝑅𝑡+1 − 𝑅𝐵,𝑡+1 ), (19)
8
and
𝜂𝑡 = 𝔼𝑡 Λ𝑡,𝑡+1 Ω𝑡+1 𝑅𝑡+1 . (20)
The ratio (18) represents the discounted differential of the rate of return on loans over the costs of raising domestic funds, this is
what is known as the bank spread While (19) represents the comparison of deposit costs with external debt costs, finally, Eq. (20) is
the value discounted from local costs. The variable Ω is made up of two terms; the first corresponds to the probability of leaving the
banking industry 1 − 𝜃; while the second term corresponds to the sum of the asset holding benefits, 𝜈𝑡 𝜙, plus the benefits of an extra
unit of deposits, 𝜂𝑡 , both weighted by the probability of survival. In other words, Ω𝑡 is a weighted average of marginal benefits and
is defined by
Ω𝑡 = (1 − 𝜃) + 𝜃(𝜈𝑡 𝜙𝑡 + 𝜂𝑡 ). (21)
Note that 𝜈𝑡 , 𝜇𝑡 and 𝜂𝑡 are independent of factors specific to each bank, and therefore 𝜙𝑡 is also independent. This suggests that (16) is
valid in the aggregate, that is, it represents the solution to the all-bank problem. This implication is also supported by Hypothesis 1 and
Proposition 2.
We, deduct the evolution of the aggregate net worth. It is assumed that a fraction 𝜃 of the banks, at the end of the period 𝑡,
manage to survive in the industry, so that they have an equity equal to 𝑁𝑒𝑡 . Integrating for all the banks 𝑗 in the domain [0, 1] we
1
have 𝑁𝑒𝑡 = 𝑁𝑒𝑡,𝑗 𝑑 𝑗 . This is equivalent to saying
∫0
𝑁𝑒𝑡 = 𝜃[Γ(𝜔𝑡 )𝑅𝐾,𝑡 𝑄𝑡−1 𝑆𝑡−1 − 𝑅𝑡 𝐷𝑡−1 − 𝑒𝑡−1 𝑅𝐵,𝑡 𝐵𝑡−1 ]𝜉𝑡𝑁 ,
where 𝜉𝑡𝑁 is a shock to bank capital that survivors face. On the other hand, the 1 − 𝜃 fraction of banks leave financial industry and
an equal number enters. The banks that go out of business transfer their remaining earnings to households and, at the same time,
households transfer a fraction 𝜅 of these to the new banks. So the capital of the new banks, 𝑁𝑛𝑡 , is given by
𝑁𝑛,𝑡 = 𝜅(1 − 𝜃)−1 Γ(𝜔𝑡 )𝑅𝐾,𝑡 𝑄𝑡−1 𝑆𝑡−1 .
Hence, the evolution of aggregate bank capital, 𝑁𝑡 , is the weighted sum of bank capital that leaves and enters the industry 𝑁𝑡 =
𝜃𝑁𝑒𝑡 + (1 − 𝜃)𝑁𝑛𝑡 , that is
𝑁𝑡 = 𝜃[Γ(𝜔𝑡 )𝑅𝐾,𝑡 𝑄𝑡−1 𝑆𝑡−1 − 𝑅𝑡 𝐷𝑡−1 − 𝑒𝑡−1 𝑅𝐵,𝑡 𝐵𝑡−1 ]𝜉𝑡𝑁 + 𝜅Γ(𝜔𝑡 )𝑅𝐾 ,𝑡 𝑄𝑡−1 𝑆𝑡−1 . (22)
Aggregate deposits are obtained by combining (16) with (10)
𝐷𝑡 = (𝜙𝑡 − 1)𝑁𝑡 − (1 + 𝜗)𝑒𝑡 𝐵𝑡 . (23)
3.3. Goods producers firms
At the end of period 𝑡 the entrepreneur 𝑗 establishes the capital amount 𝑄𝑡 𝐾𝑗,𝑡+1 for the period 𝑡 + 1, which finances with credits,
𝑆𝑗,𝑡+1 , which they acquire from financial intermediaries, and with their own resources, 𝑁𝑡𝑒 (business capital). Thus, the balance sheet
of the firms is defined by
𝑒
𝑄𝑡 𝐾𝑗,𝑡+1 = 𝑄𝑡 𝑆𝑗,𝑡+1 + 𝑁𝑗,𝑡 +1
.
The returns get from your investment projects are made up of two elements; one the average return, 𝑅𝐾,𝑡+1 , and the other an
idiosyncratic risk component 𝜔𝑡+1 that follows a log-normal distribution, log 𝜔 ∼  (−0.5𝜎𝜔2 , 𝜎𝜔2 ). This component also captures the
asymmetric information problem that exists between the banker and the businessman.
Since the idiosyncratic component has a support ℝ+ , a limit is set for 𝜔𝑡 , given by 𝜔𝑡+1 , which represents the point at which
companies may or may not meet their debt obligations with banks. Thus, the space ℝ+ is divided into two parts. Firstly, if 𝜔𝑡+1 ≥ 𝜔𝑡+1
implies that the entrepreneur meets its debt obligations, so that the cost of credit is determined on the return on equity; 𝑍𝑗,𝑡+1 𝑆𝑗,𝑡+1 =
𝜔𝑡+1 𝑅𝐾,𝑡+1 𝑄𝑡 𝐾𝑗,𝑡+1 . Where, 𝑍𝑗,𝑡 is the credit interest rate. Secondly, if 𝜔𝑡+1 ≤ 𝜔𝑡+1 the businessman does not meet his debt, so the
banker is forced to carry out monitoring, which implies costs that are indexed on the return on business capital, 𝜇𝑏 𝜔𝑡+1 𝑅𝐾,𝑡+1 𝑄𝑡 𝐾𝑗,𝑡+1 ,
where 𝜇𝑏 is a parameter representing the cost unit for monitoring the company. In this way, the residual profits that the banks obtain
is (1 − 𝜇𝑡 )𝜔𝑡+1 𝑅𝐾,𝑡+1 𝑄𝑡 𝐾𝑗,𝑡+1 .
Taking these two cases into account, the expected profits of both entrepreneurs and bankers are determined. The following optimal
contract problem is then obtained.
{ ∞ }
[ ]
max 𝜔𝑓 (𝜔)𝑑𝜔 − 1 − 𝐹 (𝜔) 𝜔 𝑅𝐾,𝑡+1 𝑄𝑡 𝐾𝑡+1
{𝜔,𝐾} ∫𝜔
subject to
{ }
𝜔 [ ]
(1 − 𝜇𝑏 ) 𝜔𝑓 (𝜔)𝑑𝜔 + 1 − 𝐹 (𝜔) 𝜔 𝑅𝐾,𝑡+1 𝑄𝑡 𝐾𝑡+1 ≥ 𝑅𝑡+1 𝑆𝑗,𝑡 .
∫0
9
where 𝑓 (𝜔) is the probability distribution of 𝜔 (PDF) and 𝐹 (𝜔) represents the cumulative probability distribution (CDF). This contract
problem involves maximizing the return on business capital subject to the banker’s participation constraint. From the first-order
conditions, that can be deduced
( )
𝑄𝑡 𝐾𝑡+1
𝑅𝐾,𝑡+1 = Ψ 𝑅𝑡+1 . (24)
𝑁𝑡𝑒+1
This expression represents the financial accelerator for Bernanke et al. (1999). This means that the risk premium, 𝑅𝐾,𝑡+1 ∕𝑅𝑡+1 , is an
increasing function of the value of the investment relative to the company’s net worth. That is, Ψ(.)′ > 0 and Ψ(1)′ = 1. Following
Céspedes et al. (2004) the functional form of Ψ(𝑔) is given by Ψ(𝑔) = 𝑔 𝜇𝑠 , where 𝜇𝑠 > 0 is the elasticity of the function Ψ(𝑔) evaluated
in steady-state.
The entrepreneurs then rent out labor and capital to produce consumer goods using a production function, 𝑌𝑡 = 𝐹 (𝐴𝑡 , 𝐾𝑡 , 𝐿𝑡 ),
Cobb-Douglas
𝑌𝑡 = 𝐴𝑡 𝐾𝑡𝛼 𝐿𝑡1−𝛼 ,
where 𝛼, 𝛼 ∈ (0, 1), is the capital-output elasticity and 𝐴𝑡 is Total Factor Productivity (TFP) that follows a stochastic process. The
solution to the profit maximization problem provide
𝑌𝑡
𝑤𝑡 = (1 − 𝛼)𝑝𝐻,𝑡 , (25)
𝐿𝑡
and
⎡ 𝑌𝑡+1 ⎤
⎢ 𝛼𝑝𝐻,𝑡 𝐾 + (1 − 𝛿)𝑄𝑡+1 ⎥
𝑡+1
𝔼𝑡 𝑅𝐾,𝑡+1 = 𝔼𝑡 ⎢ ⎥. (26)
⎢ 𝑄𝑡 ⎥
⎢ ⎥
⎣ ⎦
In addition, taking into account the expected benefits, the law of movement of business capital can be obtained
𝑁𝑡𝑒+1 = 𝛾 𝑒 𝑉𝑡𝑒 + 𝑊𝑡𝑒 , (27)
where 𝛾𝑒 represents the survival probability of the entrepreneur in the industry and 𝑉𝑡𝑒 the entrepreneurial is given by
⎧ 𝜔 ⎫
⎪ 𝜇𝑏 𝜔𝑓 (𝜔)𝑅𝐾,𝑡 𝑄𝑡−1 𝐾𝑡 𝑑𝜔 ⎪
⎪ ∫ ⎪
𝑉𝑡𝑒 = 𝑅𝐾,𝑡 𝑄𝑡−1 𝐾𝑡 − ⎨𝑅𝑡 + 0
𝑒
𝑒
⎬(𝑄𝑡−1 𝐾𝑡 − 𝑁𝑡 ). (28)
⎪ 𝑄 𝐾
𝑡−1 𝑡 − 𝑁 𝑡 ⎪
⎪ ⎪
⎩ ⎭
The firms that do not survive, leave the industry and consume their wealth 𝐶𝑡𝑒 = (1 − 𝛾 𝑒 )𝑉𝑡𝑒 and offer their work in the labor market,
from where they obtain 𝑊𝑡𝑒 .
3.4. Capital producers firms
Like households, capital-producing firms face domestic investment goods, 𝐼𝐻,𝑡 , and imported investment goods 𝐼𝐹 ,𝑡 . The aggrega-
tion of these two goods is given by the CES function
[ 𝜂 −1 𝜂 −1
] 𝜂𝑖
1 1 𝑖 𝑖 𝜂𝑖 −1
𝜂 𝜂 𝜂
𝐼𝑡 = (1 − 𝛾𝑖 ) 𝜂𝑖 𝐼𝐻,𝑡𝑖 + 𝛾𝑖 𝑖 𝐼𝐹 ,𝑡𝑖 , (29)
where 𝛾𝑖 ∈ (0, 1) is the share of each investment over the total and 𝜂𝑖 > 0 is the elasticity of substitution between both goods. The first
order conditions to the cost minimization problem 𝑝𝑡 𝐼𝑡 = 𝑝𝐻,𝑡 𝐼𝐻,𝑡 + 𝐼𝐹 ,𝑡 are given by
( )
𝑝𝐻,𝑡 −𝜂𝑖
𝐼𝐻,𝑡 = (1 − 𝛾𝑖 ) 𝐼𝑡 , (30)
𝑝𝑡
and
( )−𝜂𝑖
1
𝐼𝐹 ,𝑡 = 𝛾𝑖 𝐼𝑡 . (31)
𝑝𝑡
These firms then maximize the following problem
{ [ ( )] }
∑∞
𝐼𝑡+𝑖
max 𝔼𝑡 Λ𝑡,𝑡+𝑖 𝑄𝑡+𝑖 𝐼𝑡+𝑖 − 1 + 𝑓 𝐼𝑡+𝑖 .
{𝐼𝑡 }𝑡=0
∞
𝑖=0
𝐼𝑡+𝑖−1
This problem incorporates some investment adjustment costs that the properties meet; 𝑓 (1) = 𝑓 ′ (1) = 0 and 𝑓 ′′ (.) > 0. The specific
function comes according to Christiano et al. (2010),
( ) [ √ ( 𝐼𝑡 ) √ ( 𝐼 ) ]
𝐼𝑡 1 𝑎 𝐼 −1 − 𝑎 𝐼 𝑡 −1
𝑓 = 𝑒 𝑡−1 +𝑒 𝑡−1 −2 .
𝐼𝑡−1 2
10
The parameter 𝑎 represents the curvature of 𝑓 (.). The first-order condition provides the price of capital
( ) ( ) ( ) ( )
𝐼𝑡 𝐼 𝐼𝑡 𝐼𝑡+1 2 ′ 𝐼𝑡+1
𝑄𝑡 = 1 + 𝑓 + 𝑡 𝑓′ − 𝔼𝑡 Λ𝑡,𝑡+1 𝑓 . (32)
𝐼𝑡−1 𝐼𝑡−1 𝐼𝑡−1 𝐼𝑡 𝐼𝑡
3.5. Commodity sector and exchange rate
As in Fernández et al. (2018) and Bodenstein et al. (2018) the small economy has an endowment, 𝐶 𝑜 (𝐶 𝑜 > 0), of commodities
that nature provides and the supply to the world market is assumed to be inelastic at its price. It is also assumed that households are
the only agents that exploit these resources and therefore they are the only ones that obtain the income given by 𝑌𝑡𝐶𝑜 , which also
represents the benefits Π𝐶𝑜 𝐶𝑜
𝑡 = 𝑌𝑡 . That is to say, there is no other agent involved in the exploitation of raw materials, so there are
no transfers or other types of elements.
Since it is an endowment of nature, there is no production technology, there is no investment costs or capital accumulation.
Therefore, there is no optimization problem of any kind. Thus, income from commodities is defined by
𝑌𝑡𝐶𝑜 = 𝑝𝐶𝑜
𝑡 𝐶𝑜. (33)
where 𝑝𝐶𝑜
𝑡 is the relative price of commodities for the domestic economy, whose fundamental factor is the prices quoted in international
markets. At this price we denote by 𝑝𝐶𝑜 𝑡
∗ and assume that it follows a first order autoregressive process. Our interest is to establish
the relationship between the exchange rate and the price of commodities.
Proposition 3. The real exchange rate, 𝑒𝑡 , is negatively related to commodity prices 𝑝𝐶𝑜
𝑡
∗,
( 𝐶𝑜∗ )−1
𝑒𝑡 = 𝑝𝐶𝑜
𝑡 𝑝𝑡 (𝑝𝑡 )−1 . (34)
( 𝐶𝑜∗ )
When writing in general terms, 𝑒𝑡 = 𝜁 𝑝𝑡 with 𝜁 ′ (𝑝𝐶𝑜
𝑡
∗ ) < 0. This implies that an increase (fall) in commodity prices generates an appreciation
(depreciation) of the real exchange rate.
If we express in terms of logarithmic deviations from long-term equilibrium, 𝑒̂𝑡 = log 𝑒𝑡 − log 𝑒𝑠𝑠 and 𝑝̂𝐶𝑜
𝑡
∗ = log 𝑝𝐶𝑜∗ − log 𝑝𝐶𝑜∗ , we
𝑡 𝑠𝑠
get that; 𝑐𝑜𝑟𝑟(𝑒̂𝑡 , 𝑝̂𝐶𝑜
𝑡
∗ ) < 0.
In Fig. 5 the negative correlation between the exchange rate and commodity prices is empirically observed, both expressed as
percentage deviations from the trend. The average correlation oscillates around −0.66 between both variables. If Argentina, which
has a small correlation, is excluded, the average is −0.75. In any case, the relationship between both variables is significantly high.
This suggests that in periods of falls in commodity prices, gray bars, the exchange rate experiences a depreciation, and conversely, in
periods of boom in raw materials the exchange rate appreciates. This empirical observation supports the function (62), which shows
a decreasing function.
3.6. External sector
The economy is open both in the commercial sector and in the financial sector, this is summarized in the balance of payments
accounts. On the commercial side, the current account is given by the trade balance and the payment of interest on foreign debt
made by banks. In particular, the trade balance is made up of commodity exports, 𝑝𝐶𝑜 𝑡 𝐶 𝑜 , and other goods, 𝑝𝐻,𝑡 𝐶𝐻,𝑡 , while imports
∗
correspond to consumer goods, 𝐶𝐹 ,𝑡 , and investment goods, 𝐼𝐹 ,𝑡 . Thus the current account is
𝐶 𝐴𝑡 = (𝑝𝐶𝑜
𝑡 𝐶 𝑜 + 𝑝𝐻,𝑡 𝐶𝐻,𝑡 ) − (𝐶𝐹 ,𝑡 + 𝐼𝐹 ,𝑡 ) − 𝑅𝐵,𝑡 𝑒𝑡 𝐵𝑡 .
∗
(35)
The external demand for domestic goods is given by

( )
𝑝𝐻,𝑡 𝜀𝑒 ∗
𝐶𝐻,𝑡
∗
= 𝑌𝑡 , (36)
𝑒𝑡
where 𝜀𝑒 is the elasticity of demand and 𝑌𝑡∗ is external production, which is exogenous.
On the international finance side, it is assumed that local banks acquire external debt denominated in dollars which is recorded
in the financial account given by
𝐹 𝐴𝑡 = 𝑒𝑡 𝐵𝑡 − 𝑒𝑡−1 𝐵𝑡−1 . (37)
For the acquisition of this debt, financial intermediaries must pay interest to international investors. This interest rate has two
components, an exogenous part - international interest rate - 𝑅∗𝑡 and an endogenous part - exchange rate risk. In equilibrium, bankers
are indifferent between obtaining deposits or external debt, so that 𝑅𝑡 = 𝑅𝐵,𝑡 ,
[ ]
𝑒𝑡+1
𝔼𝑡 𝑅𝐵,𝑡+1 = 𝔼𝑡 𝑅∗𝑡+1 . (38)
𝑒𝑡
11
Fig. 5. Commodity prices and exchange rate. The logarithmic deviation of the trend was obtained using the HP method (𝜆 = 1600).
3.7. General equilibrium and driving forces
The external equilibrium must satisfy that 𝐶𝐴𝑡 + 𝐹 𝐴𝑡 = 0, that is, the balance of payments must be zero. From (35) to (37) it is
obtained trade balance (𝑇 𝐵𝑡 ),
𝑇 𝐵𝑡 = (1 + 𝑅𝐵,𝑡 )𝑒𝑡 𝐵𝑡 − 𝑒𝑡−1 𝐵𝑡−1 . (39)
The macroeconomic close implies that the GDP is defined as
𝜔
𝐺𝐷𝑃𝑡 = 𝑝𝑡 𝐶𝐻,𝑡 + 𝑝𝑡 𝐼𝐻,𝑡 + 𝜇𝑏 𝜔𝑑 𝑓 (𝜔)𝑅𝐾 ,𝑡 𝑄𝑡 𝐾𝑡 + 𝑝𝑡 𝑇 𝐵𝑡 . (40)
∫0
The aggregate output of the economy is equal to the sum of the production of goods and commodities 𝐺𝐷𝑃𝑡 = 𝑌𝑡 + 𝑌𝑡𝐶𝑜 . The law of
motion of physical capital is
( )
𝐼𝑡
𝐾𝑡+1 = (1 − 𝛿)𝐾𝑡 + 𝐼𝑡 − 𝑓 𝐼. (41)
𝐼𝑡−1 𝑡
The exogenous variables are defined by the following stochastic process, which in compact form is
log z𝑡+1 = (1 − 𝜌z ) log z𝑠𝑠 + 𝜌z log z𝑡 + 𝜺z𝑡+1 .
where z = {𝐴, 𝑝𝐶𝑜∗ , 𝑌 ∗ , 𝜉 𝑁 , 𝑅∗ } is a set of exogenous variables, z𝑠𝑠 is the steady state, |𝜌z | < 1 are the persistence coefficients of each
process and 𝜺z𝑡 ∼  (0, 𝜎z2 ) is a bank noise. General equilibrium is defined as follows:
Definition 1. Given the set of parameters 𝜽, the initial conditions x0 and the contingent shock sequences {𝜺𝑡 }∞ 𝑡=0
, general equilibrium is
defined as a set of contingent allocations of quantities {y𝑡 }∞
𝑡=0
and prices {p𝑡 }∞
𝑡=0
that solve simultaneously; the problem of households,
financial intermediaries, firms and that markets are clearing.
4. Quantitative analysis
In this section, we simulate the model and proceed as follows. First, to discipline the model we partition the set of parameters into
three subsets of parameters. The first subset of parameters corresponds to a simple parameterization, that is, numerical values are
assigned to the parameters taking into account previous studies. The second set of parameters is calibrated, which means that they are
obtained endogenously from the steady-state of the model. The third subset is formally estimated, for this, we use Bayesian methods,
12
Table 1
Calibrated parameters.
Definition Argentina Brazil Chile Colombia Mexico Peru Average
Discount factor 𝛽 0,988 0,988 0,988 0,988 0,988 0,988 0,988

Relative risk aversion coefficient 𝜎 2,000 2,000 2,000 2,000 2,000 2,000 2,000
Scale parameter in labor supply 𝜓𝐿 2,240 6,940 16,440 7,650 2,240 10,690 7,700
Inverse of labor supply elasticity 𝜑 0,620 0,580 0,580 0,580 0,620 0,580 0,593
Governing import share in cons. 𝛾𝑐 0,400 0,360 0,480 0,230 0,400 0,090 0,327
Elasticity of substitution - cons 𝜂𝑐 0,430 0,430 0,430 0,430 0,430 0,430 0,430
Fraction of disposal of resources Θ 0,400 0,400 0,400 0,400 0,400 0,400 0,400
Prob. survival of banks 𝜃 0,960 0,960 0,960 0,960 0,960 0,960 0,960
Scale of inv. adjustment costs 𝑎 0,750 0,750 0,750 0,750 0,750 0,750 0,750
Governing import share in inv. 𝛾𝑖 0,400 0,130 0,580 0,600 0,400 0,820 0,488
Elasticity of substitution - inv. 𝜂𝑖 0,430 0,430 0,430 0,430 0,430 0,430 0,430
Capital depreciation rate 𝛿 0,030 0,024 0,024 0,024 0,020 0,024 0,024
Std. dev. the normal log-dist 𝜎𝜔 0,280 0,280 0,280 0,280 0,280 0,280 0,280
Audit costs 𝜇𝑏 0,120 0,120 0,120 0,120 0,120 0,120 0,120
Elasticity of the function Ψ(𝑔) 𝜇𝑠 0,020 0,020 0,020 0,020 0,020 0,020 0,020
Capital share in production 𝛼 0,320 0,320 0,390 0,340 0,320 0,370 0,343
Survival rate of firms 𝛾𝑒 0,960 0,960 0,960 0,960 0,960 0,960 0,960
Price elasticity of exports 𝜀𝑒 1,180 1,180 1,180 1,180 1,180 1,180 1,180
Interest rate elasticity of debt-GDP Ω𝑢 0,001 0,001 0,001 0,001 0,001 0,001 0,001
these parameters, for the most part, have short-term effects, but not long-term. Once all the parameters have their corresponding
values, we then solve the model and then capture the impulse response functions in the face of commodity shocks. In particular, we
quantify the effects of bank balance sheets on output. We then run a bootstrapping analysis to see how balance sheet effects extend
business cycles.
4.1. Parameterization and calibration
Let 𝜽1 , with 𝜽1 ⊂ 𝜽, be the first subset of parameters, whose numerical values are assigned taking into account the antecedents.
This subset is defined by
𝜽1 = {𝛽, 𝜎, 𝑎, 𝜑, 𝜓 𝐿 , 𝛾𝑐 , 𝜂𝑐 , 𝛾𝑖 , 𝜂𝑖 , 𝛿, 𝜇𝑏 , 𝜇𝑠 , 𝛼, 𝑎, Θ, 𝜃, 𝛾 𝑒 , 𝜀𝑒 , Ω𝑢 }.
Most of the values were obtained from Fernández et al. (2018) and for all the countries in the sample (See Table 1), except for Argentina
and Mexico, since these are not part of the authors’ analysis. For this, the two countries consider two sources that are consistent with
the long-term characteristics. From Garcia-Cicco et al. (2010)6 we obtain the set {𝜓 𝐿 , 𝜑, 𝛼, 𝛿} whose values are assigned as follows;
𝜓 𝐿 = 2.24 and 𝜑 = 0.62. The quarterly depreciation rate is set at 0.03 for Argentina and 0.02 for Mexico, while the capital-output
elasticity, 𝛼, is equal to 0.32 for both countries. While the parameters 𝛾𝑐 and 𝛾𝑖 , for these two countries, were taken from Galí and
Monacelli (2005) and whose values are; 𝛾𝑐 = 𝛾𝑖 = 0.4.
Since the Fernández et al. (2018) model does not incorporate financial frictions, then the parameters related to the optimal contract
were necessary to take from Bernanke et al. (1999). Thus, the standard deviation of the distribution log 𝜔 ∼  (−0.5𝜎𝜔2 , 𝜎𝜔2 ), was set
to 𝜎𝜔 = 0.28, while the monitoring cost parameter was set at 𝜇𝑏 = 0.12 and the companies’ survival rate at 𝛾 𝑒 = 0.96. The elasticity
of the corporate leverage function, Ψ(𝑔), was taken from Céspedes et al. (2004) and corresponds to the value of 𝜇𝑠 = 0.02. All these
parameters are the same for all countries.
The second subset of parameters 𝜽2 , with 𝜽2 ⊂ 𝜽, are endogenously calculated from the steady state. This subset is given by:
𝜽2 = {𝜗, 𝐶 𝑜 , 𝐵 }
The parameter that captures the degree of international financial friction, 𝜗, is calibrated taking into account the expressions (18) and
𝑅 − 𝑅𝐵
(19) and the relation 𝜈𝑡 = 𝜗−1 𝜇𝑡 , established in Proposition 1. The explicit expression is 𝜗 = . The domestic risk-free rate,
Γ(𝜔)𝑅𝐾 − 𝑅
𝑅, is approximated by the deposit interest rate and 𝑅𝐵 is determined by the international interest rate, 𝑅𝐵 = 𝑅∗ . In this way, the
numerator, 𝑅 − 𝑅∗ , represents the country risk. As for the return on capital, 𝑅𝐾 is approximated by the loan interest rate and Γ(𝜔) is
determined endogenously in the CSV problem. The resulting expression for each country is given by
𝐸𝑀𝐵𝐼𝑗
𝜗𝑗 = .
Γ𝑗 (𝜔)𝑅𝑗,𝐾 − 𝑅𝑗
Being 𝑗 = 1, 2, 3, 4, 5, 6 that represents the country 𝑗, in alphabetical order. Using the averages of the statistical series for each 𝑗 on the
variables; 𝐸𝑀 𝐵𝐼 , 𝑅𝐾 and 𝑅 can be obtained from 𝜗𝑗 . The average for the set of countries is given by 𝜗 = 0.517.
The parameters of the endowment of commodities and external bank debt, 𝐶 𝑜 and 𝐵 , respectively, are obtained in such a way
as to minimize the distance of the model ratios concerning the observed ratios. That is, we consider the steady state as a restricted
6
These authors examine the properties of business cycles for Argentina and Mexico, for which they use a model of real cycles for an open economy.
13
Table 2
Long-run ratios: modela and data.
Long-run ratios observed Argentina Brazil Chile Colombia Mexico Peru Average
Data Model
Consumption/GDP 65,3 62,0 60,8 66,9 66,8 65,3 64,5 65,2

Investment/GDP 16,1 18,4 22,2 22,1 21,5 21,4 20,3 20,6
Exports/GDP 17,9 12,8 35,3 16,9 29,4 23,7 22,7 19,6
Imports/GDP 14,6 12,7 30,9 20,5 31,0 21,8 21,9 19,4
Imported Invest./Investment 28,8 3,6 40,0 40,0 6,1 66,8 30,9 28,7
Home Invest./Investment 71,2 96,4 60,0 60,0 93,9 33,2 69,1 71,3
Imported Cons./Consumption 8,9 13,0 30,4 12,0 3,6 4,2 12,0 17,0
Home Cons./Consumption 91,1 87,0 69,6 88,0 96,5 95,8 88,0 83,0
Commodities Exports/GDP 6,3 8,5 26,2 6,4 11,0 12,3 11,8 11,04
External Real Interest Rate 17,7 6,0 3,2 4,9 4,1 4,6 6,8 4,9
Bank External Debt/GDP 11,6 24,1 30,9 10,7 10,7 20,3 18,0 18,3
Credit internal / GDP 10,5 37,1 60,4 30,8 16,3 18,8 29,0 30,3
optimization problem, where the restrictions correspond to the long-term ratios observed in the data (The observed ratios are those
that appear in Table 2, taking into account the average values). We consider this way of calibrating for disciplining the model. In this
way, the optimal calibrated values are; 𝐶 𝑜 = 0.77 and 𝐵 = 1.43.
Generally speaking, the model replicates long-term relationships reasonably well. In Table 2 these model relationships are re-
ported compared to those observed. First, you need to replicate the ratios; external bank debt/GDP and export of commodities/GDP.
Regarding the first ratio, the model provides a value of 18.3% while the data shows a value of 18%. Regarding the second ratio, the
model suggests 11.04% and the data 11.8%. These results show that the model reproduces these long-term relationships quite well.
If other conventional ratios are observed, such as consumption/GDP, investment/GDP, exports/GDP, among others, the model is also
capable of replicating the data.
4.2. Bayesian estimation
The subset of parameters 𝜽3 , 𝜽3 ⊂ 𝜽, is formally estimated using Bayesian techniques. Most of this set of parameters govern
short-term dynamics
𝑁
𝜽3 = {𝜌𝐶𝑜 , 𝜌𝐴 , 𝜌𝑌 , 𝜌𝜉 , 𝜌𝑅 , 𝜎𝐶𝑜 , 𝜎𝐴 , 𝜎𝑌 ∗ , 𝜎𝜉𝑁 , 𝜎𝑅∗ }.
∗ ∗
To estimate we consider time series for the following variables; Commodity price index (𝑝𝐶𝑜 𝑡
∗ ), real GDP (GDP), real domestic credit
(𝑆𝑡 ), world GDP (𝑌𝑡 ) and international real interest rate (𝑅𝑡 ). The latter two are approximated using data for the United States. In
∗ ∗
particular, the variable 𝑅∗𝑡 refers to the 3-month interest rate. All the information is defined in quarterly frequency, which goes from
the first quarter of 2000 to the third quarter of 2018. So there are 75 observations. The set of observable variables are defined by y𝑡
as
∗
y𝑡 = { [log(𝐺𝐷𝑃𝑡 )],  [log(𝑝𝐶𝑜
𝑡
∗
)],  [log(𝑆𝑡 )],  [log(𝑌𝑡∗ )], (𝑅∗𝑡 − 𝑅 )}75
𝑡=1
.
where,  is the acronym for the Hodrick-Prescott filter. This means that the variables represent logarithmic deviations from their
trend. In the case of the international interest rate, it was not necessary to apply the HP filter, since it does not present a trend, only
the stocking was removed. In this way, all variables are stochastic processes with zero mean and constant variance.
The priors of the parameters are shown in Fig. 6, dotted line. A beta distribution, , was chosen for the parameter 𝜅 since they
represent proportions, so their domain is bounded. Similarly, the persistence coefficients of stochastic processes also follow this type
of probabilistic distribution. In contrast, the parameter that captures the curvature of the investment adjustment cost function, 𝑎, has
a gamma distribution, Γ, because it has an upper tail. Whereas the standard deviations of stochastic shocks have an inverse gamma
distribution, Γ−1 . The details of each distribution, the priors and the posteriors can be seen in Table 5 of Appendix A.
The posteriors of the parameters are obtained using the standard random walk Metropolis–Hastings algorithm, with 5000 repeti-
tions of 100 periods and with an acceptance rate of 38%. The results (mean of the posterior) are observed in Fig. 6, all parameters
are estimated with a confidence of 90%. The parameter representing transfer of resources to the new banks, 𝜅, is 6%. As for the
persistence parameter of the AR (1) process that follows commodity prices, it has a value of 0.76 with a deviation of more or less than
22%, that is, this parameter occurs in the interval 0.655 ≤ 𝜌𝐶𝑜∗ ≤ 0.861. This interval suggests that commodity shocks are persistent
over time, which may have important implications on the transition dynamics of the variables. The 𝜎𝐶𝑜 estimator is 0.08, which
implies a shock magnitude of 8%. For its part, the persistence coefficients of the AR (1) TFP process is 0.78 and its standard deviation
is 0.0282 (≈ 0.03). In general, most posteriors are statistically different from priors, suggesting that the data contains information
about the parameters.
14
Fig. 6. Prior and posterior of parameters.
4.3. Impulse-response analysis
In this section we analyze the effects of commodity shocks on the behavior of the financial system and the real economy. In
particular, we compare the results of the model that includes liability dollarization with another one that excludes dollarization. For
practical purposes, the benchmark model is labeled as the “model with liability dollarization” while the other model is labeled as the
“model without dollarization”. The latter is equivalent to noting that banks’ external debt is denominated in domestic currency and
formally follows the following restrictions. The bank’s balance sheet, given by (10), changes
𝑄𝑡 𝑆𝑗,𝑡 = 𝑁𝑗,𝑡 + 𝐷𝑗,𝑡 + 𝐵𝑗𝑡 .
While the evolution of the bank capital, given by (11), now is
𝑁𝑗,𝑡+1 = Γ(𝜔𝑡+1 )𝑅𝐾,𝑡+1 𝑄𝑡 𝑆𝑗,𝑡 − 𝑅𝑡+1 𝐷𝑗,𝑡 − 𝑅𝐵,𝑡+1 𝐵𝑗𝑡 .
The solution to the problem (12) follows the same procedure. Thus, the credit bid is now given by
𝑄𝑡 𝑆𝑡 + 𝜗𝐵𝑡 = 𝜙𝑡 𝑁𝑡 .
In addition to this consideration, the balance of payments closure also excludes dollarization and therefore the uncovered interest
rate parity is replaced by an expression equivalent to that of Schmitt-Grohé and Uribe (2003). Clearly, this model is a particular case
of the full model.
Next, both models are subjected to a positive commodity price shock equal to an 8% standard deviation. Fig. 7 shows the results of
the impulse response functions. The solid black line represents the dynamics of the model with liability dollarization, while the dashed
blue line represents the model without liability dollarization. Overall, both models suggest similar qualitative behavior. However,
there are important differences in quantitative terms. At the time of impact, output reacts by up to 1.5% in the model that includes
liability dollarization, while the other model suggests a reaction of 1.1%. This pattern is also observed in the rest of the variables.
The transmission channel suggests that the boom in commodity prices generates an appreciation of the domestic currency, which
leads banks to have a greater preference for funding in foreign markets. Thus, external leverage (𝑒𝑡 𝐵𝑡 ∕𝑁𝑡 ) increases with respect to
its equilibrium, which implies an increase in the value of external debt. This increase in debt generates pressure on bank liabilities
and this induces an increase in credit. The increase in credit, and according to the companies’ balance sheets, has a positive effect on
investment, which in turn positively affects the output.
It is well known that these models are symmetric to the type of shock (positive or negative), the responses of the variables are
symmetric to a positive or negative shock. In the face of a negative commodity price shock, the above results would be interpreted
15
Fig. 7. Models with and without balance sheets to commodity shocks.
Table 3
Percentiles of simulated cycles (Percentages).
Percentiles 1 5 95 99
Output With dollarization −0,38 −0,28 0,29 0,38

Without dollarization −0,28 −0,19 0,21 0,27
as declines concerning the steady-state. In general terms, the results have important implications when acquiring short-term dollar-
denominated debt. This is meaningful because it shows how balance sheets, and the financial system in general, can amplify output
deviations. The question that arises now is whether or not the dollarization of external liabilities volatility of business cycles, that
is, how does this financial mechanism affect the variance of business cycles? To answer this question we perform a Monte Carlo
simulation.
4.4. Effects during expansions and recessions
We run a resampling exercise to approximate the variance of the output in expansions and recessions. Taking into account the
solution of the model with and without balance sheets, 10,000 simulations of 200 periods are carried out. Besides, the cyclical
component of the product is obtained using the HP filter and then, the averages of the 10,000 simulations in both models are calculated
(for each moment of time). The results of this experiment can be seen in Fig. 8. Clearly the simulation of the cycles suggests greater
volatility in the presence of bank balance sheets and suggests less volatility in the absence of balance sheets. Specifically, output
volatility in the model with bank balance sheets is 0.17% compared to 0.15% in the other model. These figures may appear to be
small, however, the graph shows that there are periods when volatility is very high, particularly in the boom and bust phases.
To systematically quantify these rare but important events, the 1st, 5th, 95th, and 99th percentiles of the simulated cycles are
calculated in both models. In Table 3 the results are reported, which suggest that the negative values are below the trend and are
captured by the 1st and 5th percentiles, meanwhile the positive values are above the trend and are captured by the 95th and 99th
percentiles. At the 1st and 5th percentiles, the model with bank balance sheets generates a greater depth of the cycle compared to
16
Fig. 8. Business cycle simulation. Note: Given that the initial conditions of the model condition the simulation of the cycles, we have decided to
eliminate the first 100 simulations.
Fig. 9. Probability distribution of the variance business cycle.
the model without a balance sheet, this means that balance sheets amplify economic recessions. On the other hand, at the 95th and
99th percentiles, the balance sheet model also generates greater fluctuation compared to the other model, which suggests a greater
expansion of the cycles.
Then, we calculate the standard deviation for each of the 10,000 simulated series and obtain the probability distributions for this
set. In Fig. 9 the results are reported. The Y axis represents the probability density and the X axis represents the standard deviation of
each series, expressed in percentage terms. The blue bars correspond to the model that includes balance sheets and the red bars, those
that exclude this financial element. The black vertical dashed lines are the means of the standard deviations, the findings suggest that
output volatility shows a fairly significant gap. This pattern is also observed in the rest of the variables, such as external bank debt
and external leverage, which show a significant gap in the volatility of the cycles of the model with a balance sheet compared to the
model without a balance sheet.
17
Overall, the results show that dollar-denominated debt can amplify macroeconomic cycles. These results also raise macroprudential
policy discussions and challenges for policymakers. Then, the question we ask ourselves is; Given the existence of the amplifying effect
of balance sheets, can macroprudential policy mitigate the effects of commodity shocks? In the next section, we discuss this aspect.
5. Macroprudential policy experiments
In this section, we examine how macroprudential policy may or may not cushion the effects of commodity price shocks, we focus
on the regulation of bank capital requirements established in the Basel rules. These regulations indicate that banks are subject to
capital requirements, according to which at least a fraction of bank loans must be financed with their own capital. This regulation
aims to curb excessive risk-taking by banks.
There are two groups of literature. The first group of literature has concentrated on examining the effects of capital requirements,
established in Basilea-I (1988) and Basilea-II (2004), on the macroeconomy (See, for example, Aliaga-Díaz and Olivero, 2011; Covas
and Fujita, 2010; Jordà et al., 2017; Zhang, 2009; Zhu, 2008), argue that these requirements had a negative effect on the economy
due to the rigidity of regulation. An important feature when approaching the model is that the capital requirements are constant over
time, in addition to considering a closed economy and productivity shocks.
While the second group of literature has been focused on examining the role of time-varying capital requirements (See, for example,
Agenor et al., 2018; Aliaga-Díaz et al., 2018; Covas and Fujita, 2010; De Resende et al., 2016; Tomura, 2018), which are mainly based
on the new Basilea-III (2010) framework that incorporates additional requirements such as the countercyclical buffer and suggests
explicitly considering the phases of the business cycle7 . This bibliography addresses, like the previous one, from a closed economy
perspective and takes into account, as a central role, productivity shocks.
Thus, there is a gap to consider the possibility of examining the role of macroprudential policy in an open economy context and
the option of considering external shocks, such as commodity prices.
Conventionally, the capital requirement is defined as follows.
Bank capital
Capital r equir ement =
Risk weighted assets
For simplicity, we assume that the denominator in the second member is composed of two types of risks; credit risk and market risk.
The first type of risk, which is symbolized by 𝑄𝑡 𝑆𝑡 , refers to the possibility that the debtor cannot pay his debt, while the second type
of risk, 𝑚
𝑡 , refers to the possibility of incurring losses due to price fluctuations, fundamentally exchange rate fluctuations. On the
whole, the capital requirement ratio, 𝜏𝑡 , is defined by
𝑁𝑡
𝜏𝑡 = . (42)
𝑄𝑡 𝑆𝑡 + 𝑚
𝑡
To model 𝜏𝑡 we consider two types of experiments. First, we explore two types of regulatory regimes (fixed regime and countercyclical
regime), based on Basilea-II (2004) because most of the Latin American economies continue to apply these regulations. Second, we
explore the effects of Basilea-III (2010), which suggests taking into account the movements of business cycles.
5.1. Basel II
The first experiment consists of exploring the effects of two types of regulatory regimes; fixed and countercyclical. The fixed regime
assumes that the regulation remains constant at every moment of time, while the countercyclical regime assumes that the regulation
is variable in time. For modeling purposes, we follow the strategy implemented by Covas and Fujita (2010). These authors assume
that 𝜏𝑡 depends on the aggregate state of the economy and approximates this state through TFP. In our case we assume that the state
of the economy is determined by the prices of commodities, this is justified in the literature and our results, because a significant
fraction higher than the TFP of the economy is explained by commodity prices. In short 𝜏𝑡 = 𝜏(𝑝𝐶𝑜 𝑡
∗ ), and the functional form of 𝜏(.)
𝐶𝑜
Is given by (𝑝𝑡 ) ,
∗ 𝛾1
( ∗ )𝛾1
𝜏𝑡 = 𝜏𝐵 𝑝𝐶𝑜
𝑡 , (43)
where 𝜏𝐵 is a fixed parameter established in Basel I and II, in addition, allows capturing the regulatory regimes
⎧ 𝜏𝐵 , if 𝛾1 = 0
⎪ 𝜏𝐵
𝜏𝑡 = ⎨ ( 𝐶𝑜∗ )𝛾1 , if 𝛾1 < 0
𝑝(𝑡 )
⎪ ∗ 𝛾1
⎩𝜏𝐵 𝑝𝐶𝑜 𝑡 , if 𝛾1 > 0
The first case shows that regulation is fixed at each moment of time, 𝜏𝑡 = 𝜏𝐵 , while the second case implies that regulation is procyclical.
These two cases are those studied by Covas and Fujita (2010) and which has also been widely explored in the literature. Our interest
lies in determining the effects of a countercyclical regulation, when 𝛾1 > 0 against commodity shocks.
7
This Basilea-III (2010) emerged after the financial crisis of 2008 intending to solve the deficiencies of the previous rules. The new rule suggests
that in phases of expansion, banks are obliged to accumulate more capital to be used in phases of recession.
18
Fig. 10. Macroprudential policy - Basel II.
Taking into account the reference model, a model with bank balance sheets, we incorporate the expressions (42) and (43) as
rules of macroprudential policies. The parameter 𝜏𝐵 has a value of 𝜏𝐵 = 0.08 established in Basel II8 And 𝛾1 = 8 as in Covas and
Fujita (2010)9 .
Fig. 10 shows the results of the fixed and countercyclical regimes compared to the results of the reference model. Faced with a
positive commodity shock, it is observed that the banking regulation with a fixed regime amplifies the effects of this shock on the
financial system and the real sector of the economy. However, this effect is dampened by countercyclical regulation, both internal
and external leverage decrease compared to the reference model. The credit response in the absence of regulation, at the moment of
impact, also tends to be larger in the fixed regime than in the countercyclical regime. This behavior is also observed in the real sector
of the economy.
The results suggest that a banking regulation policy that takes into account the aggregate state of the economy may be useful,
regardless of the magnitude of the capital requirement, indeed it suggests that this type of regulation can dampen the amplifying
effects of external shocks. However, it does not explicitly consider the phases of the business cycle, to take this aspect into account,
we model the coefficient 𝜏𝑡 in a different way following the Basel III recommendations.
5.2. Basel III
The second experiment consists of taking into account the business cycles explicitly. Basel III notes notes; “The objective is to ensure
that the banking sector as a whole has the capital available to help maintain the flow of credit in the economy without questioning
its solvency when the financial system experiences stress after a period of excessive credit growth...” [Basel Committee (2009)].
To capture and evaluate the effects of this type of policy, we followed the strategy implemented by De Resende et al. (2016) and
8
We assume that 𝜏𝐵 is common in all countries. However, the specific requirements of each country can be considered, but this apparent het-
erogeneity does not affect the transition dynamics of the variables, since it only has scale effects in addition to being constant at each moment of
time.
9
Since the authors study the procyclicality of regulation and therefore use a value of 𝛾1 = −8, while we we study the countercyclical policy, so
𝜏𝐵 = 8.
19
Table 4
Basel II and basel III countercyclical policy (In percentages).
Differentials
Variables Benchmark Basel II Basel III
Benchmarck -basel II Benchmarck -basel III
Internal credit 0.34 0.23 0.19 0.11 0.15

(32.35) (44.11)
Output 1.54 1.43 1.19 0.30 0.35
(7.14) (22.72)
Note: The figures in the second, third and fourth columns correspond to the reactions of the variables at the time of the commodity
shock. For example, 0.34 represents the response of domestic credit to the shock at the time of impact (reference model with bank
balance sheets), while 0.23% is the response of the same variable in the model incorporated by Basel II and 0.19% according to Basel
III. Idem for the output case, the figures in parentheses correspond to the relative gaps of each policy concerning the reference model.
Aliaga-Díaz et al. (2018). These authors assume that capital requirements depend on the business cycle and the financial cycle, which
determine the credit conditions of the economy (𝐶𝐶𝑡 ). That is to say the capital requirement is given by
( ) ( )
𝜏𝑡 𝜏𝑡−1
log = 𝜓1 log + (1 − 𝜓1 )𝜓2 𝐶𝐶𝑡 , (44)
𝜏𝐵 𝜏𝐵
where 𝜓1 is a parameter that captures the persistence of the capital requirement gap. While 𝜓2 is the Basel III buffer and 𝜏𝐵 is the
requirement set by regulation. The credit conditions the index is composed of a weighted average between the business cycle and the
financial cycle.
𝐶𝐶𝑡 = 𝜂𝐵 (𝐺𝐷𝑃𝑡 − 𝐺𝐷𝑃 ) +(1 − 𝜂𝐵 ) (𝑄𝑡 𝑆𝑡 − 𝑄𝑆 ), (45)
⏟⏞⏞⏞⏞⏞⏞⏞⏞⏟⏞⏞⏞⏞⏞⏞⏞⏞⏟ ⏟⏞⏞⏞⏞⏞⏟⏞⏞⏞⏞⏞⏟
Business Cycle Financial Cycle
where 𝜂𝐵 is a weight of the two types of cycles. If the economy is in its expansionary phase, 𝐺𝐷𝑃𝑡 > 𝐺𝐷𝑃 , ceteres paribus, then
the requirement increases connection with the reference regulation, that is, log 𝜏𝑡 > log 𝜏𝐵 . Conversely, when the economy is in its
recessionary phase, 𝐺𝐷𝑃𝑡 < 𝐺𝐷𝑃 , regulation decreases with regard to the reference regulation log 𝜏𝑡 < log 𝜏𝐵 . When the economy is
in equilibrium, then regulation remains constant. An analogous interpretation can be made with financial cycles. When the credit
level is above its trend, 𝑄𝑡 𝑆𝑡 > 𝑄𝑆 , then log 𝜏𝑡 > log 𝜏𝐵 , and vice versa. Our analysis is more interesting in an open economy context.
Let us remember that domestic credit is determined, among others, by external bank debt, 𝑒𝑡 𝐵𝑡 , and this in turn is determined by
commodity prices. When the economy and the financial system are in their expansionary phases, due to a commodity shock, credit
conditions grow and this induces a higher requirement of bank capital.
To carry out the numerical experiment, we parameterize the set {𝜏𝐵 , 𝜓1 , 𝜓2 , 𝜂𝐵 }. Taking into account the specific requirements of
each country10 , We can obtain that 𝜏𝐵 = 12%. This value does not include countercyclical capital buffers. While the parameter 𝜓2
does include the countercyclical buffer and is chosen to coincide with a maximum increase of 2.5%, as established in Basel III. The
regulation smoothing parameter 𝜓1 is chosen so that a change in requirements lasts four periods (one year), 𝜓1 = 0.75, 𝜂𝐵 is assumed
to be allocated at 𝜂𝐵 = 0.5, that is, both types of cycles are equally important for the credit condition index.
Fig. 11 shows the impulse response of this policy compared to the reference model. The results suggest that, in the face of a positive
commodity price shock, countercyclical banking regulation tends to cushion the deviation of variables from long-term equilibrium.
As in the previous case, it is observed that the financial sector reduces both the internal leverage and the external leverage, which
have important effects on domestic credit. This suggests that banks, in order to comply with the norm, accumulate capital in times
of expansion, which affects the level of credit, which decreases. This is consistent with the spirit of the regulation since it seeks to
prevent banks from taking excessive risk and, therefore, prevents domestic credit growth. In the real sector of the economy there is
also a cushioning effect.
5.3. Countercyclical regime: basel II vs. basel III
The similarity of Basel II’s countercyclical policies with Basel III is that the bank capital requirement coefficient is variable over
time, however, the difference is that the former takes into account only the state of the economy, while the second specifically
considers business cycles and financial cycles determined by external shocks.
Now we compare the effectiveness of Basel II and Basel III against the benchmark. The results suggest that the Basel III recom-
mendations may be more effective than Basel II (See Fig. 12). In other words, determining the coefficient 𝜏𝑡 taking into account the
stages of business cycles can be important to cushion the impacts of external shocks. As a matter of fact, there is a quantitatively
significant difference between Basel III and Basel II, Table 4 shows the magnitudes of the variables credit and product, in terms of
the reference model. At the moment of impact, it is observed that the Basel III regulation has a much more significant riot effect than
Basel II. Domestic credit is reduced 0.15% using Basel III compared to the reference model (which does not include regulation), while
10
These specific requirements are; In Argentina it is set at 11.5%, in Brazil, Chile and Mexico at 10.5%, Colombia at 9% and Peru at 10%.
20
Fig. 11. Macroprudential policy - Basel III.
Basel II reduced 0.11%. Clearly, the Basel III recommendations are much more effective than those established in Basel II. Similar
results are observed for the output case, it is reduced by 0.35% using Basel III versus the reference model and 0.30% using Basel II.
5.4. Welfare analysis
We examine the implications of macroprudential policies for social welfare. We define well-being as in Faia and Mona-
celli (2007), the well-being of the economy is a weighted sum of household consumption and business consumption. However,
as Bernanke et al. (1999) emphasize, the fraction of business consumption over aggregate consumption can reasonably be assumed
to be negligible. Therefore, we consider the household utility function as our objective. In a scenario without politics, conditional
welfare is given by
∑
∞
0 = 𝔼0 𝛽 𝑡 𝑈 (𝐶𝑡 , 𝐿𝑡 ), (46)
𝑡=0
while welfare in a regime with politics is
∑
∞
0∗,𝜀 = 𝔼0 𝛽 𝑡 𝑈 ((1 + 𝜀)𝐶𝑡 , 𝐿𝑡 ), (47)
𝑡=0
where 𝜀 is the fraction of consumption that the household would need in each period in the no-policy regime to obtain the same
welfare in the policy-intervention regime. In other words, 𝜖 represents the welfare gains expressed in terms of equivalent consumption.
Formally, 𝜀 must resolve the equality 0∗,𝜀 = 0 . However, since the utility function is of type GHH, there is no closed expression
for 𝜀.
To quantify and compare well-being we rewrite the value functions in their recursive form as in Gertler and Karadi (2011) and
then use a second order approximation of Schmitt-Grohé and Uribe (2004). This method is used because stochastic shocks and control
21
Fig. 12. Macroprudential policy - Basel III vs. Basel II.
parameters in policy regimes affect the transitions of variables and the steady-state, so the method allows incorporating these effects
into the welfare calculation11 .
We carry out two exercises, both of which consider countercyclical macroprudential policies. We compare the welfare that would
be obtained under Basel III with the welfare of the regime without policies. Then, we compare welfare under Basel II with welfare
without politics. Fig. 13 shows the behavior of the welfare curves that would be obtained in both macroprudential policy regimes
compared to the welfare that would be obtained without policy. Both curves start at the same point, coordinate (0.8%), which means
that all variables start in the initial non-stochastic steady state. At that point, the banking regulation establishes a capital requirement
of 8% and the equivalent consumption ratio is zero, since welfare is the same in the steady state. Faced with a commodity price
shock and with policy intervention, social welfare increases. In fact there is a maximum welfare in a reasonable range of 𝜏𝐵 , if the
welfare gains in both types of policies are compared, it is observed that Basel III generates greater welfare gains than Basel II. The
welfare-maximizing bank capital requirement coefficient in Basel III is 13%.
6. Confronting with data: DSGE vs. SVAR
In this section, we compare the model with the data. We try to answer the question of whether or not the model can reproduce
the data, to achieve this we compare the dynamics of the DSGE model with the dynamics of an SVAR model.
This way of evaluating the predictive capacity of our model consists of comparing the impulse-response of the DSGE model with
an SVAR model. Both models take into account the role of the dollarization of external liabilities. Both models take into account
the role of the dollarization of external liabilities, the specification of the SVAR model corresponds to that outlined in Section 2, as
well as the variables, the frequency of the data, and their periodicity. The process that follows the commodity prices in both models
11
It is well known that the first-order approximation, by construction, ignores the effects of parameter changes and shocks on transitions and the
steady state
22
Fig. 13. Welfare gains under different macroprudential policy regimes.
are the same, as a result of this, the estimator of the persistence coefficient, 𝜌𝐶𝑜∗ and the estimator of the standard deviation of the
shocks, 𝜎𝐶𝑜∗ are also the same.
In general terms and from a qualitative point of view, the DSGE model reproduces the transition dynamics reasonably well
(Fig. 14). At the moment of impact, the exchange rate, country risk, external debt and domestic credit, given by the DSGE model,
react in a similar way to that of the SVAR model, given that they are positioned in the confidence intervals of the data. The first three
variables show more persistence in the model than in the data, unlike credit, which shows little persistence. Regarding the dynamics
of the output, the model seems to overestimate the reaction. At the time of impact, the DSGE model predicts a 1.5% deviation from
steady state and the SVAR model suggests a 0.98% deviation. The direction and sign of the output in the DSGE model is similar to
the data.
7. Conclusions
The prices of raw materials have played an important role in the economic behavior of emerging market countries, particu-
larly dependent on these resources. Understanding transmission channels has been a challenge for the international macroeconomy,
empirical evidence and theoretical models have proposed that the trade balance and real markets constitute a key transmission mech-
anism of commodity price shocks on business cycles. However, the role of the financial system, specifically bank balance sheets, as
a transmission mechanism in the presence of commodity price shocks has been neglected. This is an extremely important matter
because much of the emerging markets are actively involved in financial globalization. Furthermore, the macro-financial literature
has posited a close relationship between financial markets and the real economy. Consequently, formalizing and quantifying the role
of bank balance sheets as an alternative mechanism can help to understand how commodity shocks to the economy are transmitted
and propagated.
In this document we have examined the effects of commodity prices on business cycles in Latin American countries, emphasizing
that bank balance sheets, or the dollarization of external liabilities, constitute a transmission channel. Our findings suggest that the
reaction that the output experiences is quantitatively important when considering this financial mechanism compared to an economy
that does not consider this channel. In fact, simulations of a series of commodity shocks in each period indicate that bank balance
sheets amplify expansions and deepen economic recessions. Specifically, the volatility of business cycles is largeret at the highs and
lows of the cycles. However, the role of countercyclical macroprudential policies, based on bank capital requirements that vary over
time, make it possible to mitigate the adverse effects of external shocks, it dampens these effects by making the cycles much smoother.
In addition, the intervention of these types of policies can help improve social welfare, particularly when considering the Basel III
recommendations.
The lessons learned from the results are that dollarization of bank liabilities can have both advantages and disadvantages. It can
be advantageous when international markets are growing, because it helps the banks of domestic economies to have access to greater
23
Fig. 14. Impulse response to commodity shock: DSGE vs. SVAR.
resources at lower costs, nevertheless, it is disadvantageous when international markets are in decline, because it negatively affects
bank balance sheets and the real economy. In this context, the application of countercyclical macroprudential policies can help to
build financial markets that are more resilient to adverse external shocks.
24
Appendix A. Tables and figures
Table 5
Priors and posteriors of estimated parameters.
Prior Posterior Interval Metropolis Posterior

Definition Symbol Distribution
Mean Std. Dev. Mean Std. Dev. HDP 90% Hasting Maximization
Transfer to entering bankers 𝜅  0,05 0,04 0,06 0,04 [0,001 ; 0,005 0,005
0,135]
Persistence of commodities 𝜌𝐶𝑜∗  0,30 0,20 0,76 0.22 [0,651 ; 0,008 0,008
prices 0,839]
Persistence of TFP 𝜌𝐴  0,75 0,10 0,78 0,10 [0,678 ; 0,396 0,393
0,894]
𝜌𝑌 
∗
Persistence of external 0,80 0,10 0,86 0,10 [0,794 ; 0,944 0,926
demand 0,924]
𝜉𝑁
Persistence of bank capital 𝜌  0,70 0,10 0.90 0,10 [0,903 ; 0,052 0,061
0,967]
𝑅∗
Persistence, world interest 𝜌  0,50 0,10 0,70 0,10 [0,623 ; 0,799 0,801
rate 0,774]
Std. Dev., Commodity shock 𝜎𝐶𝑜∗ Γ−1 0,08 ∞ 0,08 ∞ [0,069 ; 0,757 0,769
0,093]
Std. Dev., TFP shock 𝜎𝐴 Γ−1 0,01 ∞ 0,03 ∞ [0,024 ; 0,780 0,788
0,032]
Std. Dev., external demand 𝜎𝑌 ∗ Γ −1
0,01 ∞ 0,01 ∞ [0,004 ; 0,863 0,863
shock 0,006]
Std. Dev., bank capital shock 𝜎𝜉𝑁 Γ−1 0,01 ∞ 2,73 ∞ [1.579 ; 0,934 0,935
3.720]
Std. Dev., world interest rate 𝜎𝑅∗ Γ−1 0,01 ∞ 0,01 ∞ [0.007 ; 0,701 0,704
shock 0.009]
Marginal Density of Likelihood (Modified Harmonic Average) 801,634
Marginal Density of Likelihood (Laplace approximation) 801,663
Appendix B. Mathematical appendix
Proof Proposition 1.. From (10) we solve 𝐷𝑗,𝑡 and substitute in (15), from which we obtain
𝑉𝑗,𝑡 (𝑆𝑗,𝑡 , 𝐵𝑗,𝑡 , 𝐷𝑗,𝑡 ) = 𝜈𝑡 𝑄𝑡 𝑆𝑗,𝑡 + 𝜇𝑡 𝑒𝑡 𝐵𝑗,𝑡 + 𝜂𝑡 𝑁𝑗,𝑡 , (48)
where,
𝜂𝑠,𝑡
𝜈𝑡 = − 𝜂𝑡
𝑄𝑡
𝜂𝑏,𝑡
𝜇𝑡 = 𝜂𝑡 −
𝑒𝑡
The hypothesis of the solution (16), or conjecture solution, is equivalent to (48), so they are used interchangeably. The problem is
solving (48) subject to (13). To do this, we use the Lagrange function  = (𝑄𝑡 𝑆𝑗,𝑡 , 𝑒𝑡 𝐵𝑗,𝑡 , 𝜆𝑡 ), defined by
[ ]
 = 𝑉𝑗,𝑡 (𝑆𝑗,𝑡 , 𝐵𝑗,𝑡 , 𝐷𝑗,𝑡 ) + 𝜆𝑡 𝑉𝑗,𝑡 (𝑆𝑗,𝑡 , 𝐵𝑗,𝑡 , 𝐷𝑗,𝑡 ) − Θ(𝑄𝑡 𝑆𝑗,𝑡 + 𝜗𝑒𝑡 𝐵𝑗,𝑡 ) ,
where 𝜆𝑡 is the Lagrange multiplier. The first order conditions with respect to each of the arguments of , respectively, are given by
(1 + 𝜆𝑡 )𝜈𝑡 = 𝜆𝑡 Θ (49)
(1 + 𝜆𝑡 )𝜇𝑡 = 𝜆𝑡 Θ𝜗 (50)
𝜈𝑡 𝑄𝑡 𝑆𝑗,𝑡 + 𝜇𝑡 𝑒𝑡 𝐵𝑗,𝑡 + 𝜂𝑡 𝑁𝑗,𝑡 = Θ(𝑄𝑡 𝑆𝑗,𝑡 + 𝜗𝑒𝑡 𝐵𝑗,𝑡 ) (51)
From (49), (50) you can eliminate 𝜆𝑡 , from which it follows that 𝜇𝑡 = 𝜗𝜈𝑡 . Substituting this relationship in (51) shows the relationship
of the supply of credits
𝑄𝑡 𝑆𝑗,𝑡 = 𝜙𝑡 𝑁𝑗,𝑡 − 𝜗𝑒𝑡 𝐵𝑗,𝑡 , (52)
25
where
𝜂𝑡
𝜙𝑡 = , (53)
Θ − 𝜈𝑡
with which Proposition 1 is demonstrated. □
Proof Proposition 2.. To verify that the value function is linear in 𝑆𝑡 , 𝐷𝑡 and 𝐵𝑡 , we first substitute (53) in (48) and then we use the
fact that 𝜇𝑡 = 𝜗𝜈𝑡 , from which we immediately get that:
𝑉𝑗,𝑡 (𝑆𝑗,𝑡 , 𝐵𝑗,𝑡 , 𝐷𝑗,𝑡 ) = (𝜈𝑡 𝜙𝑡 + 𝜂𝑡 )𝑁𝑗𝑡 (54)
Replacing (54) in the Bellman Eq. (14) and then using the bank capital’s law of motion:
[ ]
𝑉𝑗,𝑡 (𝑆𝑗,𝑡 , 𝐵𝑗,𝑡 , 𝐷𝑗,𝑡 ) = 𝔼𝑡 Λ𝑡,𝑡+1 (1 − 𝜃)𝑁𝑗,𝑡+1 + 𝜃 max 𝑉𝑗,𝑡+1 (𝑆𝑗,𝑡+1 , 𝐵𝑗,𝑡+1 , 𝐷𝑗,𝑡+1 )
[ ]
= 𝔼𝑡 Λ𝑡,𝑡+1 (1 − 𝜃)𝑁𝑗,𝑡+1 + 𝜃(𝜈𝑡+1 𝜙𝑡+1 + 𝜂𝑡+1 )𝑁𝑗𝑡+1
[ ]
= 𝔼𝑡 Λ𝑡,𝑡+1 (1 − 𝜃) + 𝜃(𝜈𝑡+1 𝜙𝑡+1 + 𝜂𝑡+1 ) 𝑁𝑗,𝑡+1
Thus, we can rewrite as follows:
𝑉𝑗,𝑡 (𝑆𝑗,𝑡 , 𝐵𝑗,𝑡 , 𝐷𝑗,𝑡 ) = 𝔼𝑡 Λ𝑡,𝑡+1 Ω𝑡+1 𝑁𝑗,𝑡+1 (55)
where,
Ω𝑡 = (1 − 𝜃) + 𝜃(𝜈𝑡 𝜙𝑡 + 𝜂𝑡 ) (56)
Using the bank capital motion law, defined in (11), we have:

[ ]
𝑉𝑗,𝑡 (𝑆𝑗,𝑡 , 𝐵𝑗,𝑡 , 𝐷𝑗,𝑡 ) = 𝔼𝑡 Λ𝑡,𝑡+1 Ω𝑡+1 Γ(𝜔𝑡+1 )𝑅𝐾,𝑡+1 𝑄𝑡 𝑆𝑗,𝑡 − 𝑅𝑡+1 𝐷𝑗,𝑡 − 𝑒𝑡 𝑅𝐵,𝑡+1 𝐵𝑗𝑡
From which it can easily be deduced that 𝑉𝑗,𝑡 (𝑆𝑗,𝑡 , 𝐵𝑗,𝑡 , 𝐷𝑗,𝑡 ) is a linear function of 𝑆𝑗,𝑡 , 𝐵𝑗,𝑡 , 𝐷𝑗,𝑡 . Taking into account the balance sheet
we can replace 𝐷𝑗,𝑡 by its equivalent and using the conjecture solution (48) we obtain the coefficients 𝜈𝑡 , 𝜇𝑡 and 𝜂𝑡 .
𝜈𝑡 = 𝔼𝑡 Λ𝑡,𝑡+1 Ω𝑡+1 (Γ(𝜔𝑡+1 )𝑅𝐾,𝑡+1 − 𝑅𝑡+1 ) (57)
𝜇𝑡 = 𝔼𝑡 Λ𝑡,𝑡+1 Ω𝑡+1 (𝑅𝑡+1 − 𝑅𝐵,𝑡+1 ) (58)
𝜂𝑡 = 𝔼𝑡 Λ𝑡,𝑡+1 Ω𝑡+1 𝑅𝑡+1 (59)
With which Proposition 2 is demonstrated. □
Proof Proposition 3. First we define the real exchange rate in a conventional way.
𝑡 𝑃𝑡∗
𝑒𝑡 = (60)
𝑃𝑡
where 𝑡 is the nominal exchange rate, defined as the price of the foreign currency in terms of the local currency, 𝑃𝑡∗ the price index
of the foreign economy and 𝑃𝑡 is the price index of the domestic economy.
Next, the relative prices are established for both the domestic economy and the foreign economy, since 𝑃𝐹 ,𝑡 is the numerary,
then we can define 𝑝𝐶𝑜 𝐶𝑜 𝐶𝑜∗ = 𝑃 𝐶𝑜∗ ∕𝑃 ∗ = 𝑃 𝐶𝑜∗ ∕𝑃 ∗ as the
𝑡 = 𝑃𝑡 ∕𝑃𝐹 ,𝑡 as the relative price of commodities in the local economy and 𝑝𝑡 𝑡 𝐹 ,𝑡 𝑡 𝑡
relative price of commodities in the foreign economy. This last term is obtained under the assumption that 𝑃𝐹∗,𝑡 = 𝑃𝑡∗ .
In the absence of transaction costs or other barriers to trade, the law of one price is met, that is 𝑃𝑡𝐶𝑜 = 𝑡 𝑃𝑡𝐶𝑜∗ . Expressing in
relative terms is obtained.
( )( 𝐶𝑜∗ )( )
𝑡 𝑃𝑡𝐶𝑜∗ 𝑃𝑡𝐶𝑜∗ 𝑃𝑡∗ 𝑃𝑡 𝑃𝑡∗ 𝑃𝑡 𝑃𝑡
𝑝𝐶𝑜
𝑡 = = =
𝑃𝐹 ,𝑡 𝑃𝐹 ,𝑡 𝑃𝑡∗ 𝑃𝑡 𝑃𝑡 𝑃𝑡∗ 𝑃𝐹 ,𝑡
According to (60), the first factor of the last equality is the real exchange rate 𝑒𝑡 , while the second factor is the relative price of
commodities in the economy foreign and the third term represents the relative CPI of the domestic economy. In this way you have
to; 𝑝𝐶𝑜 𝐶𝑜∗ 𝑝 , therefore:
𝑡 = 𝑒𝑡 𝑝𝑡 𝑡
( 𝐶𝑜∗ )−1
𝑒𝑡 = 𝑝𝐶𝑜
𝑡 𝑝𝑡 (𝑝𝑡 )−1 (61)
In general terms, it can be written as follows.

( )
+ −
−
𝑒𝑡 = 𝜁 𝑝𝐶𝑜 𝐶𝑜∗
𝑡 , 𝑝𝑡 , 𝑝𝑡 (62)
26
References
Abraham, F., Cortina Lorente, J.J., Schmukler, S.L., 2020. Growth of Global Corporate Debt: Main Facts and Policy Challenges. World Bank Policy Research Working
Paper.
Agarwal, I., Duttagupta, R., Presbitero, A.F., 2020. Commodity prices and bank lending. Econ. Inq. 58 (2), 953–979.
Agenor, R.P., Alper, K., da Silva, L.P., 2018. Capital regulation, monetary policy, and financial stability. Int. J. Cent. Bank. 9 (3), 193–238.
Aldasoro, I., Ehlers, T., 2018. Global liquidity: changing instrument and currency patterns. BIS Q. Rev. 17–27. https://ddd.bis.org/publ/qtrpdf/r_qt1809b.htm.
Aliaga-Díaz, R., Olivero, M.P., 2011. Do bank capital requirements amplify business cycles? Bridging the gap between theory and empirics. Macroecon. Dyn. 16 (3),
358.
Aliaga-Díaz, R., Olivero, M.P., Powell, A., 2018. Monetary policy and anti-cyclical bank capital regulation. Econ. Inq. 56 (2), 837–858.
Aoki, K., Benigno, G., Kiyotaki, N., 2016. Monetary and Financial Policies in Emerging Markets. Unpublished paper. London School of Economics.
Basel Committee, o. B. S., 2009. Strengthening the resilience of the banking sector-consultative document.
Basilea-I, 1988. International Convergence of Capital Measurement and Capital Standards. Bank for International Settlements.
Basilea-II, 2004. International Convergence of Capital Measurement and Capital Standards: a Revised Framework. Bank for International Settlements.
Basilea-III, 2010. Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems. Bank for International Settlements.
Bernanke, B.S., Gertler, M., Gilchrist, S., 1999. The financial accelerator in a quantitative business cycle framework. Handb. Macroecon. 1, 1341–1393.
Bodenstein, M., Kamber, G., Thoenissen, C., 2018. Commodity prices and labour market dynamics in small open economies. J. Int. Econ. 115, 170–184.
Broda, C., 2004. Terms of trade and exchange rate regimes in developing countries. J. Int. Econ. 63 (1), 31–58.
Caldara, D., Cavallo, M., Iacoviello, M., 2019. Oil price elasticities and oil price fluctuations. J. Monet. Econ. 103, 1–20.
Calvo, G.A., Reinhart, C.M., 2002. Fear of floating. Q. J. Econ. 117 (2), 379–408.
Céspedes, L.F., Chang, R., Velasco, A., 2004. Balance sheets and exchange rate policy. Am. Econ. Rev. 94 (4), 1183–1193.
Christiano, L.J., Trabandt, M., Walentin, K., 2010. Dsge models for monetary policy analysis. In: Handbook of Monetary Economics, vol. 3. Elsevier, pp. 285–367.
Correia, I., Neves, J.C., Rebelo, S., 1995. Business cycles in a small open economy. Eur. Econ. Rev. 39, 1089–1113.
Covas, F., Fujita, S., 2010. Procyclicality of capital requirements in a general equilibrium model of liquidity dependence. Int. J. Cent. Bank. 6 (4), 137–173.
De Resende, C., Dib, A., Lalonde, R., Perevalov, N., 2016. Countercyclical bank capital requirement and optimized monetary policy rules. Emerg. Mark. Finance Trade
52 (10), 2267–2291.
Drechsel, T., Tenreyro, S., 2018. Commodity booms and busts in emerging economies. J. Int. Econ. 112, 200–218.
Durdu, C. B., Martin, A., Zer, I., 2019. The role of US monetary policy in global banking crises. Finance and economics discussion series 2019-039. Washington: Board
of governors of the federal reserve system.
Eberhardt, M., Presbitero, A.F., 2021. Commodity prices and banking crises. J. Int. Econ. 131, 103474.
Eichengreen, B., Hausmann, R., 1999. Exchange Rates and Financial Fragility. Technical Report. National Bureau of Economic Research.
Eichengreen, B., Hausmann, R., Panizza, U., 2003. The pain of original sin. In: Other People’s Money: Debt Denomination and Financial Instability in Emerging Market
Economies, pp. 13–37.
Eren, E., Malamud, S., 2021. Dominant currency debt. J. Financ. Econ. https://doi.org/10.1016/j.jfineco.2021.06.023 (Accessed 20 december 2021).
Faia, E., Monacelli, T., 2007. Optimal interest rate rules, asset prices, and credit frictions. J. Econ. Dyn. Control 31 (10), 3228–3254.
Fernández, A., González, A., Rodriguez, D., 2018. Sharing a ride on the commodities roller coaster: common factors in business cycles of emerging economies. J. Int.
Econ. 111, 99–121.
Fernández, A., Schmitt-Grohé, S., Uribe, M., 2017. World shocks, world prices, and business cycles: an empirical investigation. J. Int. Econ. 108, S2–S14.
Galí, J., Monacelli, T., 2005. Monetary policy and exchange rate volatility in a small open economy. Rev. Econ. Stud. 72, 707–734.
Garcia-Cicco, J., Pancrazi, R., Uribe, M., 2010. Real business cycles in emerging countries? Am. Econ. Rev. 100 (5), 2510–2531.
Gavin, M., Hausmann, R., 1996. The roots of banking crises: The macroeconomic context.
Georgiadis, G., Zhu, F., 2020. Foreign-currency exposures and the financial channel of exchange rates: eroding monetary policy autonomy in small open economies?
J. Int. Money Finance 102265.
Gertler, M., Gilchrist, S., Natalucci, F., 2007. External constraints on monetary policy and the financial accelerator. J. Money, Credit Bank. 39 (2–3), 295–330.
Gertler, M., Karadi, P., 2011. A model of unconventional monetary policy. J. Monet. Econ. 58 (1), 17–34.
Gertler, M., Kiyotaki, N., 2010. Financial intermediation and credit policy in business cycle analysis. In: Handbook of Monetary Mconomics, vol. 3. Elsevier,
pp. 547–599.
Greenwood, J., Hercowitz, Z., Huffman, G.W., 1988. Investment, capacity utilization, and the real business cycle. Am. Econ. Rev. 78 (3), 402–417.
Gruss, B., Kebhaj, S., (2019). Commodity terms of trade: A new database.
Jordà, O., Schularick, M., Taylor, A.M., 2017. Macrofinancial history and the new business cycle facts. NBER Macroecon. Annu. 31 (1), 213–263.
Kitano, S., Takaku, K., 2017. Capital controls as a credit policy tool in a small open economy. J. Macroecon. 18 (1), 20160231. https://www.degruyter.com/
document/doi/10.1515/bejm-2016-0231/html.
Kitano, S., Takaku, K., 2020. Capital controls, macroprudential regulation, and the bank balance sheet channel. J. Macroecon. 63, 103–161.
Kiyotaki, N., Moore, J., 1997. Credit cycles. J. Polit. Econ. 105 (2), 211–248.
Kose, M.A., 2002. Explaining business cycles in small open economies:how much do world prices matter? J. Int. Econ. 56 (2), 299–327.
Mendoza, E., 1995. The terms of trade, the real exchange rate, and economic fluctuations. Int. Econ. Rev. 36 (1), 101–137.
Mendoza, E.G., 1991. Real business cycles in a small open economy. Am. Econ. Rev. 797–818.
Mimir, Y., Sunel, E., 2019. External shocks, banks, and pptimal monetary policy: a recipe for emerging market central banks. Int. J. Cent. Bank. 15 (2), 235–299.
Nispi Landi, V., 2017. Capital Controls, Macroprudential Measures and Monetary Policy Interactions in an Emerging Economy. Working Paper. Bank of Italy Temi di
Discussione.
Roch, F., 2019. The adjustment to commodity price shocks. J. Appl. Econ. 22 (1), 437–467.
Schmitt-Grohé, S., Uribe, M., 2003. Closing small open economy models. J. Int. Econ. 61 (1), 163–185.
Schmitt-Grohé, S., Uribe, M., 2004. Solving dynamic general equilibrium models using a second-order approximation to the policy function. J. Econ. Dyn. Control 28
(4), 755–775.
Schmitt-Grohé, S., Uribe, M., 2018. How important are terms-of-trade shocks? Int. Econ. Rev. 59 (1), 85–111.
Shousha, S., 2016. Macroeconomic effects of commodity booms and busts: the role of financial frictions. Unpublished Manuscript.
Tomura, H., 2018. Asset illiquidity and dynamic bank capital requirements. Int. J. Cent. Bank. 10 (3), 291–317.
Uribe, M., Yue, V., 2006. Country spreads and emerging countries: who drives whom? J. Int. Econ. 69 (1), 6–36.
Zeev, N.B., Pappa, E., Vicondoa, A., 2017. Emerging economies business cycles: the role of commodity terms of trade news. J. Int. Econ. 108, 368–376.
Zhang, L., 2009. Bank Capital Regulation, the Lending Channel and Business Cycles. Working Paper.
Zhu, H., 2008. Capital regulation and banks’ financial decisions. Int. J. Cent. Bank. 4 (1), 165–211.
27

Commodity Prices Bank Balance Sheets and Macropr - 2022 - Latin American Journa

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Commodity Prices Bank Balance Sheets and Macropr - 2022 - Latin American Journa

Uploaded by

Copyright:

Available Formats

Latin American Journal of Central Banking 3 (2022) 100052

Contents lists available at ScienceDirect

Latin American Journal of Central Banking

Commodity prices, bank balance sheets and macroprudential

improve the paper

2.1. Commodity prices and bank balance sheets

Fig. 1. Credit and commodity prices.

Fig. 2. Bank external debt and commodity prices.

2.2. Empirical model

3.2. Financial intermediaries

𝑄𝑡 𝑆𝑗,𝑡 = 𝑁𝑗,𝑡 + 𝐷𝑗,𝑡 + 𝑒𝑡 𝐵𝑗𝑡 . (10)

𝑁𝑗,𝑡+1 = Γ(𝜔𝑡+1 )𝑅𝐾,𝑡+1 𝑄𝑡 𝑆𝑗,𝑡 − 𝑅𝑡+1 𝐷𝑗,𝑡 − 𝑒𝑡 𝑅𝐵,𝑡+1 𝐵𝑗𝑡 , (11)

where 𝜃 is the probability of survival in the ﬁnancial industry.

𝑉𝑗,𝑡 ≥ Θ(𝐷𝑗,𝑡 + 𝑁𝑗,𝑡 ) + Θ∗ 𝑒𝑡 𝐵𝑗,𝑡 .

𝑉𝑗,𝑡 ≥ Θ(𝑄𝑡 𝑆𝑗𝑡 + 𝜗𝑒𝑡 𝐵𝑗𝑡 ). (13)

𝑄𝑡 𝑆𝑗,𝑡 + 𝜗𝑒𝑡 𝐵𝑗,𝑡 = 𝜙𝑡 𝑁𝑗,𝑡 , (16)

where 𝜙 represents bank leverage given by

Proof. See Appendix B. □

𝜇𝑡 = 𝔼𝑡 Λ𝑡,𝑡+1 Ω𝑡+1 (𝑅𝑡+1 − 𝑅𝐵,𝑡+1 ), (19)

Proof. See Appendix B. □

3.3. Goods producers ﬁrms

3.4. Capital producers ﬁrms

3.5. Commodity sector and exchange rate

(depreciation) of the real exchange rate.

Proof. See Appendix B. □

3.6. External sector

The external demand for domestic goods is given by

𝐹 𝐴𝑡 = 𝑒𝑡 𝐵𝑡 − 𝑒𝑡−1 𝐵𝑡−1 . (37)

3.7. General equilibrium and driving forces

Deﬁnition Argentina Brazil Chile Colombia Mexico Peru Average

Discount factor 𝛽 0,988 0,988 0,988 0,988 0,988 0,988 0,988

4.1. Parameterization and calibration

Consumption/GDP 65,3 62,0 60,8 66,9 66,8 65,3 64,5 65,2

4.2. Bayesian estimation

Fig. 6. Prior and posterior of parameters.

4.3. Impulse-response analysis

𝑄𝑡 𝑆𝑗,𝑡 = 𝑁𝑗,𝑡 + 𝐷𝑗,𝑡 + 𝐵𝑗𝑡 .

While the evolution of the bank capital, given by (11), now is

𝑁𝑗,𝑡+1 = Γ(𝜔𝑡+1 )𝑅𝐾,𝑡+1 𝑄𝑡 𝑆𝑗,𝑡 − 𝑅𝑡+1 𝐷𝑗,𝑡 − 𝑅𝐵,𝑡+1 𝐵𝑗𝑡 .

Fig. 7. Models with and without balance sheets to commodity shocks.

Output With dollarization −0,38 −0,28 0,29 0,38

4.4. Eﬀects during expansions and recessions

Fig. 9. Probability distribution of the variance business cycle.

5. Macroprudential policy experiments

Fig. 10. Macroprudential policy - Basel II.

5.2. Basel III

Internal credit 0.34 0.23 0.19 0.11 0.15

5.3. Countercyclical regime: basel II vs. basel III

Fig. 11. Macroprudential policy - Basel III.

5.4. Welfare analysis

while welfare in a regime with politics is

Fig. 12. Macroprudential policy - Basel III vs. Basel II.

6. Confronting with data: DSGE vs. SVAR

Fig. 13. Welfare gains under diﬀerent macroprudential policy regimes.

Fig. 14. Impulse response to commodity shock: DSGE vs. SVAR.

Appendix A. Tables and ﬁgures

Prior Posterior Interval Metropolis Posterior

Appendix B. Mathematical appendix

𝑉𝑗,𝑡 (𝑆𝑗,𝑡 , 𝐵𝑗,𝑡 , 𝐷𝑗,𝑡 ) = 𝜈𝑡 𝑄𝑡 𝑆𝑗,𝑡 + 𝜇𝑡 𝑒𝑡 𝐵𝑗,𝑡 + 𝜂𝑡 𝑁𝑗,𝑡 , (48)

𝜈𝑡 𝑄𝑡 𝑆𝑗,𝑡 + 𝜇𝑡 𝑒𝑡 𝐵𝑗,𝑡 + 𝜂𝑡 𝑁𝑗,𝑡 = Θ(𝑄𝑡 𝑆𝑗,𝑡 + 𝜗𝑒𝑡 𝐵𝑗,𝑡 ) (51)

𝑄𝑡 𝑆𝑗,𝑡 = 𝜙𝑡 𝑁𝑗,𝑡 − 𝜗𝑒𝑡 𝐵𝑗,𝑡 , (52)

𝑉𝑗,𝑡 (𝑆𝑗,𝑡 , 𝐵𝑗,𝑡 , 𝐷𝑗,𝑡 ) = (𝜈𝑡 𝜙𝑡 + 𝜂𝑡 )𝑁𝑗𝑡 (54)

Thus, we can rewrite as follows: