Monetary and Macroprudential Policy with Foreign Currency Loans
34 Pages Posted: 19 Aug 2015
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Monetary and Macroprudential Policy with Foreign Currency Loans
Date Written: September 10, 2014
Abstract
In a number of countries a substantial proportion of mortgage loans is denominated in foreign currency. In this paper we demonstrate how their presence affects economic policy and agents’ welfare. To this end we construct a small open economy model with financial frictions where housing loans can be denominated in domestic or foreign currency. We calibrate the model for Poland -- a typical small open economy with a large share of foreign currency loans (FCL) -- and use it to conduct a series of simulations. They show that FCLs negatively affect the transmission of monetary policy. In contrast, their impact on the effectiveness of macroprudential policy is much weaker but positive. We also demonstrate that FCLs increase welfare when domestic interest rate shocks prevail and decrease it when risk premium (exchange rate) shocks dominate. Under a realistic calibration of the stochastic environment FCLs are welfare reducing. Finally, we show that regulatory policies that correct the share of FCLs may cause a cyclical slowdown.
Keywords: foreign currency loans, monetary and macroprudential policy
JEL Classification: E32, E44, E58
Suggested Citation: Suggested Citation