[go: up one dir, main page]
IDEAS home Printed from https://ideas.repec.org/p/cid/wpfacu/106.html
   My bibliography  Save this paper

Monetary Policy and the Currency Denomination of Debt: A Tale of Two Equilibria

Author

Listed:
  • Roberto Chang
  • Andres Velasco
Abstract
Exchange rate policies depend on portfolio choices, and portfolio choices depend on anticipated exchange rate policies. This opens the door to multiple equilibria in policy regimes. We construct a model in which agents optimally choose to denominate their assets and liabilities either in domestic or in foreign currency. The monetary authority optimally chooses to float or to fix the currency, after portfolios have been chosen. We identify conditions under which both fixing and floating are equilibrium policies: if agents expect fixing and arrange their portfolios accordingly, the monetary authority validates that expectation; the same happens if agents initially expect floating. We also show that a flexible exchange rate Pareto-dominates a fixed one. It follows that social welfare would rise if the monetary authority could precommit to floating.

Suggested Citation

  • Roberto Chang & Andres Velasco, 2004. "Monetary Policy and the Currency Denomination of Debt: A Tale of Two Equilibria," CID Working Papers 106, Center for International Development at Harvard University.
    • Handle: RePEc:cid:wpfacu:106
    as

    Download full text from publisher

    File URL: https://www.hks.harvard.edu/sites/default/files/centers/cid/files/publications/faculty-working-papers/106.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Giancarlo Corsetti & Paolo Pesenti, 2002. "Self-validating optimum currency areas," Staff Reports 152, Federal Reserve Bank of New York.
    2. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear of Floating," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 117(2), pages 379-408.
    3. Burnside, Craig & Eichenbaum, Martin & Rebelo, Sergio, 2001. "Hedging and financial fragility in fixed exchange rate regimes," European Economic Review, Elsevier, vol. 45(7), pages 1151-1193.
    4. Ricardo Hausmann & Michael Gavin & Carmen Pagés-Serra & Ernesto H. Stein, 1999. "Financial Turmoil and Choice of Exchange Rate Regime," Research Department Publications 4170, Inter-American Development Bank, Research Department.
    5. Martin Schneider & Aaron Tornell, 2004. "Balance Sheet Effects, Bailout Guarantees and Financial Crises," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 71(3), pages 883-913.
    6. Paul Krugman, 1999. "Balance Sheets, the Transfer Problem, and Financial Crises," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 6(4), pages 459-472, November.
    7. Aghion, Philippe & Bacchetta, Philippe & Banerjee, Abhijit, 2000. "A simple model of monetary policy and currency crises," European Economic Review, Elsevier, vol. 44(4-6), pages 728-738, May.
    8. Ize, Alain & Yeyati, Eduardo Levy, 2003. "Financial dollarization," Journal of International Economics, Elsevier, vol. 59(2), pages 323-347, March.
    9. Mr. Olivier D Jeanne, 2003. "Why Do Emerging Economies Borrow in Foreign Currency?," IMF Working Papers 2003/177, International Monetary Fund.
    10. Ricardo Caballero & Arvind Krishnamurthy, 2005. "Exchange Rate Volatility and the Credit Channel in Emerging Markets: A Vertical Perspective," International Journal of Central Banking, International Journal of Central Banking, vol. 1(1), May.
    11. Stokey, Nancy L., 1991. "Credible public policy," Journal of Economic Dynamics and Control, Elsevier, vol. 15(4), pages 627-656, October.
    12. Hausmann, Ricardo & Panizza, Ugo & Stein, Ernesto, 2001. "Why do countries float the way they float?," Journal of Development Economics, Elsevier, vol. 66(2), pages 387-414, December.
    13. Calvo, Guillermo A, 2001. "Capital Markets and the Exchange Rate with Special Reference to the Dollarization Debate in Latin America," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(2), pages 312-334, May.
    14. Chari, V V & Kehoe, Patrick J, 1990. "Sustainable Plans," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 783-802, August.
    15. Ricardo Hausmann & Michael Gavin & Carmen Pagés & Ernesto H. Stein, 1999. "Financial Turmoil and the Choice of Exchange Rate Regime," IDB Publications (Working Papers) 4128, Inter-American Development Bank.
    16. Eduardo Moron & Juan F. Castro, 2003. "Dedollarizing the Peruvian Economy," Macroeconomics 0312005, University Library of Munich, Germany.
    17. Mr. Alain Ize & Mr. Eric Parrado, 2002. "Dollarization, Monetary Policy, and the Pass-Through," IMF Working Papers 2002/188, International Monetary Fund.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Luis Felipe Céspedes, 2005. "On the Choice and Consequences of Exchange Rate Regimes," International Finance, Wiley Blackwell, vol. 8(1), pages 151-166, March.
    2. Norbert Fiess & Rashmi Shankar, 2005. "Regime-Switching in Exchange Rate Policy and Balance Sheet Effects," Working Papers 2005_16, Business School - Economics, University of Glasgow.
    3. Alain Ize & Eduardo Levy Yeyati, 2005. "Financial De-Dollarization: Is It for Real?," Business School Working Papers isitforreal, Universidad Torcuato Di Tella.
    4. Franz Hamann & Julián Pérez & Paulina Restrepo, 2005. "Sobre los efectos macroeconómicos de la composición de la deuda pública en Colombia," Revista ESPE - Ensayos Sobre Política Económica, Banco de la República, November.
    5. Tille, Cédric, 2008. "Financial integration and the wealth effect of exchange rate fluctuations," Journal of International Economics, Elsevier, vol. 75(2), pages 283-294, July.
    6. Castillo, Paul & Montoro, Carlos, 2015. "Distribución de Ingresos y Dolarización Endógena," Working Papers 2015-002, Banco Central de Reserva del Perú.
    7. Abiad, Abdul & Bluedorn, John & Guajardo, Jaime & Topalova, Petia, 2015. "The Rising Resilience of Emerging Market and Developing Economies," World Development, Elsevier, vol. 72(C), pages 1-26.
    8. Eduardo Levy Yeyati, 2006. "Exchange Rate Regimes in the 2000s: A Latin American Perspective," Business School Working Papers exchangerate, Universidad Torcuato Di Tella.
    9. Enrique L. Kawamura & Daniel Heymann, 2005. "On Liability Dollarization: A Simple Model with Domestic and Foreign Creditors," Working Papers 80, Universidad de San Andres, Departamento de Economia, revised Feb 2005.
    10. Frankel, Jeffrey, 2010. "Monetary Policy in Emerging Markets," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 25, pages 1439-1520, Elsevier.
    11. Pelin Berkmen & Eduardo A. Cavallo, 2007. "Exchange Rate Policy and Liability Dollarization: An Empirical Study," IMF Working Papers 2007/033, International Monetary Fund.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Robert Chang & Andres Velasco, 2004. "Endogenous dollarization, expectations, and equilibrium monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
    2. Chang, Roberto & Velasco, Andres, 2006. "Currency mismatches and monetary policy: A tale of two equilibria," Journal of International Economics, Elsevier, vol. 69(1), pages 150-175, June.
    3. Luis Felipe Céspedes & Roberto Chang & Andrés Velasco, 2004. "Balance Sheets and Exchange Rate Policy," American Economic Review, American Economic Association, vol. 94(4), pages 1183-1193, September.
    4. Pelin Berkmen & Eduardo A. Cavallo, 2007. "Exchange Rate Policy and Liability Dollarization: An Empirical Study," IMF Working Papers 2007/033, International Monetary Fund.
    5. Leiderman, Leonardo & Maino, Rodolfo & Parrado, Eric, 2006. "Inflation Targeting in Dollarized Economies," Foerder Institute for Economic Research Working Papers 275699, Tel-Aviv University > Foerder Institute for Economic Research.
    6. Marcelin, Isaac & Mathur, Ike, 2016. "Financial sector development and dollarization in emerging economies," International Review of Financial Analysis, Elsevier, vol. 46(C), pages 20-32.
    7. Eduardo Levy Yeyati, 2006. "Financial dollarization: evaluating the consequences [‘A simple model of monetary policy and currency crises’]," Economic Policy, CEPR, CESifo, Sciences Po;CES;MSH, vol. 21(45), pages 62-118.
    8. Ilan GOLDFAJN & Gino OLIVARES, 2001. "Can Flexible Exchange Rates Still “Work” In Financially Open Economies?," G-24 Discussion Papers 8, United Nations Conference on Trade and Development.
    9. Honig, Adam, 2009. "Dollarization, exchange rate regimes and government quality," Journal of International Money and Finance, Elsevier, vol. 28(2), pages 198-214, March.
    10. Augusto De La Torre & Sergio L. Schmukler, 2004. "Coping with Risks through Mismatches: Domestic and International Financial Contracts for Emerging Economies," International Finance, Wiley Blackwell, vol. 7(3), pages 349-390, December.
    11. repec:idb:brikps:349 is not listed on IDEAS
    12. Frankel, Jeffrey, 2010. "Monetary Policy in Emerging Markets," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 25, pages 1439-1520, Elsevier.
    13. Aghion, Philippe & Bacchetta, Philippe & Banerjee, Abhijit, 2004. "A corporate balance-sheet approach to currency crises," Journal of Economic Theory, Elsevier, vol. 119(1), pages 6-30, November.
    14. Magud, Nicolas E., 2010. "Currency mismatch, openness and exchange rate regime choice," Journal of Macroeconomics, Elsevier, vol. 32(1), pages 68-89, March.
    15. Guillermo A. Calvo & Frederic S. Mishkin, 2003. "The Mirage of Exchange Rate Regimes for Emerging Market Countries," Journal of Economic Perspectives, American Economic Association, vol. 17(4), pages 99-118, Fall.
    16. De la Torre, Augusto & Schmukler, Sergio, 2007. "Emerging Capital Markets and Globalization: The Latin American Experience," IDB Publications (Books), Inter-American Development Bank, number 349, November.
    17. Cheng, Gong, 2015. "Balance sheet effects, foreign reserves and public policies," Journal of International Money and Finance, Elsevier, vol. 59(C), pages 146-165.
    18. Pablo Druck & Eduardo Morón & Ernesto Stein, 2001. "The Twin Risks in the Dollarization Debate: Country and Devaluation Risks," CEMA Working Papers: Serie Documentos de Trabajo. 198, Universidad del CEMA.
    19. Leonardo Leiderman & Rodolfo Maino & Eric Parrado, 2008. "Metas de inflación en economías dolarizadas," Revista de Análisis del BCB, Banco Central de Bolivia, vol. 10(1), pages 45-71, December.
    20. Augusto De La Torre & Eduardo Levy Yeyati & Sergio L. Schmukler, 2002. "Financial Globalization: Unequal Blessings," International Finance, Wiley Blackwell, vol. 5(3), pages 335-357, November.
    21. Patrick Artus, 2003. "Local Currency or Foreign Currency Debt?," Revue économique, Presses de Sciences-Po, vol. 54(5), pages 1013-1031.

    More about this item

    Keywords

    exchange rate; monetary policy; portfolio; dollarization;
    All these keywords.

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cid:wpfacu:106. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Chuck McKenney (email available below). General contact details of provider: https://edirc.repec.org/data/ciharus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.