Capital Outflows, Foreign Exchange Intervention and Reserve Requirements

The performance of a reserve requirement rule combined with foreign exchange intervention under the capital outflow shock is studied in a dynamic stochastic model of a small open economy. The model features a two-pillar toolkit of the monetary and macroprudential policies involving a hybrid Taylor rule, exchange rate regime, central bank refinancing and macroprudential adjustment for the cross-border financing. The study finds that, by a moderate appreciation through the foreign exchange intervention, managed float regime can alleviate the passive tightening pressure of interest rate to maintain adequate liquidity for the real sector. The managed float against nominal exchange rate deviations from its fundamental equilibrium value, rather than against exchange rate fluctuations, is more helpful in reducing economic volatility caused by capital outflows. The countercyclical reserve requirement ratio equipped with the central bank’s refinancing to commercial banks, can achieve the real sector growth through the adjustment of the domestic liquidity structure, while simultaneously maintain the monetary policy with a normal stance. The economic fluctuations due to the adjustment of reserve requirement ratio for foreign exchange deposits are smaller than that for domestic currency deposits, thus can more effectively deal with the shock of direct capital outflows. For the capital outflows indirectly caused by the tightening of the world risk-free interest rate, the countercyclical adjustment of reserve requirement ratio for domestic currency deposits is more appropriate