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News shocks, monetary policy, and foreign currency positions

Bianca De Paoli () and Hande Kucuk ()
Authors registered in the RePEc Author Service: Tobias Adrian (), Erkko Etula and Hyun Song Shin

No 750, Staff Reports from Federal Reserve Bank of New York

Abstract: Over the past two decades, before the global financial crisis, there was a rapid rise in the size of gross external portfolio positions as well as a decrease in the net negative foreign currency exposure in external balance sheets. In this paper, we present a theoretical model in which these portfolio facts can be explained by changes in monetary policy rules and the composition of shocks that underlie economic fluctuations. We find that policies with a strong emphasis on price stability would imply shorter positions in foreign currency when the dominant sources of fluctuations are supply shocks. The model suggests that longer and larger foreign currency positions, as observed in the data, would be consistent with a world in which central banks are more committed to price stability, and that changes in economic conditions come mainly from demand shocks. Moreover, in this case, a move toward flexible exchange rate regimes would also imply larger equilibrium portfolios and these would be tilted toward foreign assets.

Keywords: portfolio choice; international transmission of shocks; monetary policy (search for similar items in EconPapers)
JEL-codes: F31 F41 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-for, nep-ifn, nep-mon and nep-opm
Date: 2015-12-01
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