The Currency Composition Channel of Monetary Policy and the Role of Macroprudential Regulation

Abstract

Using country-level and bank-level data from several European emerging economies, we document two new facts about lending in reserve currency and monetary policy transmission. Monetary policy enacted by non-reserve currency issuers transmits across countries through bilateral trade linkages and changes the volume and share of loans denominated in reserve currency granted by the trading partners’ banking sector. Macroprudential policies initiated by the recipient country of monetary spillovers partly offset the transmission effects of monetary policies originating abroad. Our results imply that bilateral trade facilitates a foreign currency composition channel of monetary policy while active macroprudential regulation can shield the home economy from foreign monetary policy shocks.

Keywords: Foreign currency lending, Monetary policy, International spillovers, Trade linkages, Macroprudential policy, Emerging markets, Spatial econometrics

JEL Classification: C23, E5, F42, G21, G28