Dollar Shortages and Central Bank Swap Lines

Abstract

We explore the role of ‘dollar shortage’ shocks and central bank swap lines in a two-country New Keynesian model with financial frictions. Domestic banks issue both domestic and foreign currency debt and lend in domestic currency. Foreign currency-specific funding shocks, which are amplified via their effect on the exchange rate given balance sheet mismatches, lead to uncovered interest rate parity deviations, a contraction in lending and have a significant negative effect on macroeconomic variables. We show that central bank swap lines can attenuate these dynamics provided they are large enough.

Keywords: Central bank swap lines, liquidity facilities, dollar shortages, uncovered interest rate parity condition, financial frictions

JEL Classification: E32, E44, E58, F33, F41, G15