Exchange Rate Dynamics and Monetary Spillovers with Imperfect Financial Markets

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Staff Reports

Exchange Rate Dynamics and Monetary Spillovers with Imperfect Financial Markets

Previous title: “Balance Sheets, Exchange Rates, and International Monetary Spillovers”

Number 849
June 2018 Revised May 2019

JEL classification: E32, E44, F41

Authors: Ozge Akinci and Albert Queralto

We use a two-country New Keynesian model with financial frictions and dollar debt in balance sheets to investigate the foreign effects of U.S. monetary policy. Financial amplification works through an endogenous deviation from uncovered interest parity (UIP) arising from limits to arbitrage in private intermediation. Combined with dollar trade invoicing, this mechanism leads to large spillovers from U.S. policy, consistent with the evidence. Foreign monetary policies that attempt to stabilize the exchange rate reduce welfare and may exacerbate exchange rate volatility. We document empirically a link between UIP deviations and measures of credit market frictions, as predicted by the model.

Available only in PDF

Author Disclosure Statement(s)

Ozge Akinci
I declare that I have no relevant or material financial interests that relate to the research described in this staff report.

Albert Queralto
My current employer is the Board of Governors of the Federal Reserve System. The views expressed in this article are those of the authors, and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of any other person associated with the Federal Reserve System.
Other than my employer, I have not received financial support for the research described in the article submitted.

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