Heterogeneous Credit Constraints and Optimal Monetary Policy

Marco Ortiz and Gerardo Herrera
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Gerardo Herrera: Universidad del Pacífico

No 164, Working Papers from Peruvian Economic Association

Abstract: The optimal response to adverse external shocks in an economy involves the choice of a exchange rate policy. While the traditional Mundell-Flemming inspired theories support a floating exchange rate, evidence shows that central banks intervene in foreign exchange markets regularly. One of the reasons for these interventions relies on the consequences of large depreciations triggering negative balance sheet effects in economies with dollarized liabilities as shown by Benigno et al. (2013) and Devereux and Poon (2011). This paper extends this literature by introducing heterogeneity in credit constraints across sectors. Our findings support that "leaning against the wind" policy responses are optimal even when only a sector of the economy is affected by the credit constraints. Thus, relative price distortions provide an additional justification for these policies. We show that the vulnerability of the economy to large negative external shocks depends not only on the overall unhedged foreign debt, but also on its distribution across sectors.

JEL-codes: E5 F3 G15 (search for similar items in EconPapers)
Date: 2020-02
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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