Devaluations, Deposit Dollarization, and Household Heterogeneity
Francesco Ferrante () and
Nils Gornemann ()
No 1336, International Finance Discussion Papers from Board of Governors of the Federal Reserve System (U.S.)
We study the aggregate and re-distributive effects of currency devaluations in a small open economy heterogeneous households model with leverage-constrained banks. Our framework captures three stylized facts about liability dollarization in emerging economies: i) banks and firms borrow in foreign currency; ii) households save in dollar-denominated local bank deposits; and iii) such deposits are mainly held by wealthier households. The resulting currency mismatch causes an erosion of banks' net worth during a devaluation, depressing credit supply. The ensuing macroeconomic downturn is amplified by a strong reduction of consumption among poorer households in response to rising borrowing costs and falling labor income. Richer households are partially insured, as they are holding a larger share of their wealth in foreign currency denominated assets. We show that a larger currency hedging by wealthier households deepens the recession and amplifies the negative spillovers for poorer agents. When deposit dollarization is high, welfare gains can arise if monetary policy dampens a depreciation.
Keywords: Dollarization; Currency Depreciation; Household Heterogeneity; Redistribution (search for similar items in EconPapers)
JEL-codes: E21 F32 F41 (search for similar items in EconPapers)
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