Balance Sheets, Exchange Rates, and International Monetary Spillovers

Albert Queralto
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Albert Queralto: Federal Reserve Board

No 993, 2019 Meeting Papers from Society for Economic Dynamics

Abstract: We use a two-country New Keynesian model with balance sheet constraints to investigate the magnitude of international spillovers of U.S. monetary policy. Home borrowers obtain funds from domestic households in domestic currency, as well as from residents of the foreign economy (the U.S.) in dollars. In our economy, foreign lenders differ from domestic lenders in their ability to recover resources from defaulting borrowers' assets, leading to more severe financial constraints for foreign debt than for domestic borrowing. As a consequence, a deterioration in borrowers' balance sheets induces a rise in the home currency's premium and an exchange rate depreciation. We use the model to investigate how spillovers are affected by the degree of currency mismatches in balance sheets, and whether the latter make it desirable for policy to target the exchange rate. We find that the magnitude of spillovers is significantly enhanced by the degree of currency mismatches. Our findings also suggest that using monetary policy to stabilize the exchange rate is not necessarily more desirable with greater balance sheet mismatches and may actually exacerbate short-run exchange rate volatility.

Date: 2019
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mon and nep-opm
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed019:993

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