Exchange Rate Dynamics and Monetary Spillovers with Imperfect Financial Markets

82 Pages Posted: 30 May 2019

See all articles by Ozge Akinci

Ozge Akinci

Federal Reserve Bank of New York

Albert Queralto

Board of Governors of the Federal Reserve System, Global Modeling Studies

Multiple version iconThere are 2 versions of this paper

Date Written: June 2018

Abstract

We use a two-country New Keynesian model with financial frictions and dollar debt in balance sheets to investigate the foreign effects of U.S. monetary policy. Financial amplification works through an endogenous deviation from uncovered interest parity (UIP) arising from limits to arbitrage in private intermediation. Combined with dollar trade invoicing, this mechanism leads to large spillovers from U.S. policy, consistent with the evidence. Foreign monetary policies that attempt to stabilize the exchange rate reduce welfare and may exacerbate exchange rate volatility. We document empirically a link between UIP deviations and measures of credit market frictions, as predicted by the model.

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

JEL Classification: E32, E44, F41

Suggested Citation

Akinci, Ozge and Queralto, Albert, Exchange Rate Dynamics and Monetary Spillovers with Imperfect Financial Markets (June 2018). FRB of New York Staff Report No. 849 (2018), Available at SSRN: https://ssrn.com/abstract=3395526 or http://dx.doi.org/10.2139/ssrn.3395526

Ozge Akinci (Contact Author)

Federal Reserve Bank of New York ( email )

New York, NY 10045
United States

Albert Queralto

Board of Governors of the Federal Reserve System, Global Modeling Studies ( email )

Washington, DC 20551
United States

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