News Shocks, Monetary Policy, and Foreign Currency Positions

22 Pages Posted: 29 Mar 2018 Last revised: 2 Apr 2018

See all articles by Bianca De Paoli

Bianca De Paoli

London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP)

Hande Küçük

London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP); Central Bank of Turkey-Monetary Policy and Research Department

Date Written: 2015-12-01

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

JEL Classification: F31, F41

Suggested Citation

De Paoli, Bianca and Kucuk-Tuger, Hande, News Shocks, Monetary Policy, and Foreign Currency Positions (2015-12-01). Federal Reserve Bank of New York Staff Report No. 750. Available at SSRN: https://ssrn.com/abstract=2701189

Bianca De Paoli (Contact Author)

London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP) ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Hande Kucuk-Tuger

London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP) ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Central Bank of Turkey-Monetary Policy and Research Department ( email )

Istiklal Cad. 10 Ulus
06100 Ankara, Ankara 06050
Turkey

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