Carry Trades, Monetary Policy and Speculative Dynamics

41 Pages Posted: 9 Feb 2011

See all articles by Guillaume Plantin

Guillaume Plantin

University of Toulouse 1 - Toulouse School of Economics (TSE)

Hyun Song Shin

Bank for International Settlements (BIS)

Date Written: February 2011

Abstract

We ask when currency carry trades are associated with destabilizing dynamics in the foreign exchange market, and investigate the role of monetary policy rules in setting of such dynamics. In a model where the exchange rate has a long-term fundamental anchor, we find that carry trades can be stabilizing or destabilizing at shorter horizons, depending on the propensity of capital inflows to overheat the recipient economy. In the destabilizing case, we solve for a unique equilibrium that exhibits the classic pattern of the carry trade recipient currency appreciating for extended periods, punctuated by sharp falls.

Keywords: currency crises, emerging market bubbles, speculation

JEL Classification: F31, F41

Suggested Citation

Plantin, Guillaume and Shin, Hyun Song, Carry Trades, Monetary Policy and Speculative Dynamics (February 2011). CEPR Discussion Paper No. DP8224. Available at SSRN: https://ssrn.com/abstract=1758433

Guillaume Plantin (Contact Author)

University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )

Place Anatole-France
Toulouse Cedex, F-31042
France

Hyun Song Shin

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

HOME PAGE: http://www.bis.org/author/hyun_song_shin.htm

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