Balance Sheets, Exchange Rates, and International Monetary Spillovers

43 Pages Posted: 7 Jun 2018

See all articles by Ozge Akinci

Ozge Akinci

Federal Reserve Bank of New York

Albert Queralto

Federal Reserve Board - Trade and Financial Studies Section

Date Written: June 1, 2018

Abstract

We use a two-country New Keynesian model with balance sheet constraints to investigate the magnitude of international spillovers of U.S. monetary policy. Home borrowers obtain funds from domestic households in domestic currency, as well as from residents of the foreign economy (the United States) in dollars. We assume agency frictions are more severe for foreign debt than for domestic deposits. As a consequence, a deterioration in domestic borrowers’ balance sheets induces a rise in the home currency’s premium and an exchange rate depreciation. We use the model to investigate how international monetary spillovers are affected by the degree of currency mismatches in balance sheets, and whether the latter make it desirable for domestic policy to target the nominal exchange rate. We find that the magnitude of spillovers is significantly enhanced by the degree of currency mismatches. Our findings also suggest that using monetary policy to stabilize the exchange rate is not necessarily more desirable with greater balance sheet mismatches and may actually exacerbate short-run exchange rate volatility.

Keywords: financial intermediation, U.S. monetary policy spillovers, currency premium, uncovered interest rate parity condition

JEL Classification: E32, E44, F41

Suggested Citation

Akinci, Ozge and Queralto, Albert, Balance Sheets, Exchange Rates, and International Monetary Spillovers (June 1, 2018). FRB of New York Staff Report No. 849. Available at SSRN: https://ssrn.com/abstract=3191916 or http://dx.doi.org/10.2139/ssrn.3191916

Ozge Akinci (Contact Author)

Federal Reserve Bank of New York ( email )

New York, NY 10045
United States

Albert Queralto

Federal Reserve Board - Trade and Financial Studies Section ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States

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