International transmission of interest rates: the role of international reserves and sovereign debt

Antonio Afonso, Florence Huart, Joao Jalles and Piotr Stanek

No 2021/0156, Working Papers REM from ISEG - Lisbon School of Economics and Management, REM, Universidade de Lisboa

Abstract: We analyse the international transmission of interest rates by focusing onthe role of the accumulation of international reserves and on the financing of sovereign debt. An increase in foreign exchange reserves is expected to moderate the influence of U.S. interest rates.However,a high level of government debt raises the sovereign risk premium. Moreover, an increase in the stock ofgovernment debt denominated in foreign currency may increasethe expected rate of depreciation of the domestic currency. We explain the theoretical mechanisms in a model, which describes the money market equilibrium in an economy with capital account openness. Then, we test the predictions of the model for a panel of advanced and developing economies over the period 1970-2018. Our main findings are: i) significant spillovers from the U.S. interest rates to other countries, mostly for Advanced Economies; ii) a dampening effect of the share of external liabilities in the domestic currency, clearly a determinant of risk premium; iii)a negative effect of international reserves on interest rates, as expected; iv) higher reserves decrease risk premia, for long-term interest rates; v)the significanceof spilloversfades once the sovereign debtreaches100% of GDPin developed countries.

Keywords: interest rates; international reserves; government debt; spillover effects; monetary policy; fiscal policy; panel analysis (search for similar items in EconPapers)
JEL-codes: C23 E43 E63 F31 F34 G15 H60 (search for similar items in EconPapers)
Date: 2021-01
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon and nep-opm
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Related works:
Working Paper: International Transmission of Interest Rates: The Role of International Reserves and Sovereign Debt (2021)
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