Household Heterogeneity and the Transmission of Foreign Shocks

45 Pages Posted: 23 Oct 2019

See all articles by Sergio de Ferra

Sergio de Ferra

Stockholm University

Kurt Mitman

IIES

Federica Romei

Luiss Guido Carli University

Multiple version iconThere are 2 versions of this paper

Date Written: October 2019

Abstract

We study the role of heterogeneity in the transmission of foreign shocks. We build a Heterogeneous-Agent New-Keynesian Small Open Model Economy (HANKSOME) that experiences a current account reversal. Households' portfolio composition and the extent of foreign currency borrowing are key determinants of the magnitude of the contraction in consumption associated with a sudden stop in capital inflows. The contraction is more severe when households are leveraged and owe debt in foreign currency. In this setting, the revaluation of foreign debt causes a larger contraction in aggregate consumption when debt and leverage are concentrated among poorer households. Closing the output gap via an exchange-rate devaluation may therefore be detrimental to household welfare due to the heterogeneous impact of the foreign debt revaluation. Our HANKSOME framework can rationalize the observed "fear of floating" in emerging market economies, even in the absence of contractionary devaluations.

Keywords: Exchange Rate Policy, foreign currency debt, incomplete markets, Sudden stops

JEL Classification: E21, F32, F41

Suggested Citation

de Ferra, Sergio and Mitman, Kurt and Romei, Federica, Household Heterogeneity and the Transmission of Foreign Shocks (October 2019). CEPR Discussion Paper No. DP14062. Available at SSRN: https://ssrn.com/abstract=3474434

Sergio De Ferra (Contact Author)

Stockholm University ( email )

Universitetsvägen 10
Stockholm, SE-106 91
Sweden

Kurt Mitman

IIES ( email )

Stockholm, SE-10691
Sweden

HOME PAGE: http://kurtmitman.com

Federica Romei

Luiss Guido Carli University ( email )

Via O. Tommasini 1
Rome, Roma 00100
Italy

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