Monetary Policy Transmission through the Exchange Rate Factor Structure

Abstract

We show that US monetary policy is transmitted internationally through the factor structure of exchange rates. Following an unexpected easing, investment funds sell safe and buy risky currencies. Global US banks, similarly, tilt their distribution of foreign loan origination toward currencies of greater systematic currency risk. The effects of monetary policy on currency flows and loans persist for several months and feed into the leverage and real investment decisions of firms and, in particular, those that operate using a high-risk currency. We argue that currencies' factor exposures are a lens through which we can understand the international transmission of US monetary policy.

Keywords: exchange rate factor structure, monetary policy, US dollar, currency flows

JEL Classification: F31, G12, G15