nep-ifn New Economics Papers
on International Finance
Issue of 2018‒08‒27
three papers chosen by
Vimal Balasubramaniam
University of Oxford

  1. The relevance of currency-denomination for the cross-border effects of monetary policy By Isabel Argimón
  2. The Factor Content of Equilibrium Exchange Rates By Richard H. Clarida
  3. A Theory of Foreign Exchange Interventions By Sebastian Fanelli; Ludwig Straub

  1. By: Isabel Argimón (Banco de España)
    Abstract: We analyze how a change in ECB monetary policy affects lending of internationally active banks, depending on whether the currency of the claim is the one of the counterparty country, using Spanish individual bank data. We analyse the transmission from an outward perspective, exploring how banks adjust their foreign lending denominated in local and in foreign currency to changes in monetary policy, both cross-border and also through their affiliates located in other countries. We find that non-bank private claims in local currency respond much less to the ECB monetary policy stance than claims in foreign currency. We also find that the spillover effects on cross-border lending denominated in foreign currency depend on banks’ characteristics. When we broaden the analysis to include claims to the public and the financial sector, the transmission of monetary policy is mainly through foreign currency loans, but bank heterogeneity plays a role in the transmission to local currency loans. In general, a tightening of the ECB monetary policy results in an increase in lending abroad. Exchange rate changes only affect foreign currency-denominated lending.
    Keywords: monetary policy, international banking, bank credit, spillovers.
    JEL: F34 F42 G15 G21
    Date: 2018–08
  2. By: Richard H. Clarida
    Abstract: This paper develops framework to estimate and interpret the factor content of equilibrium real exchange rates. The framework – which builds on Backus, Foresi, and Telmer (2001) and Ang Piazzesi (2003) – respects the restrictions imposed by stochastic discount factors that generate standard, no arbitrage, essentially affine term structure models of inflation indexed bond yields in a home and a foreign country. We derive a sufficient set of parameter restrictions on the SDFs that deliver a stationary real exchange rate that is linear in the factors that govern the evolution of the SDFs. Our model implies that both the real exchange rate, and the ex ante real exchange rate risk premium at any horizon are linear functions of a “home” and ”foreign” factors and that inflation indexed bond yields are functions of these factors as well as a “global” factor that accounts for the observed correlation in bond yield levels across countries. Home and foreign factors in turn are simple linear functions of the level slope and curvature factors extracted from home and foreign yield curves a la Litterman and Scheinkman (1991). We find that a real exchange rate risk premium accounts for about half the variance of the dollar – pound real exchange rate and that this risk premium if fully accounted for by the traditional level, slope, and curve curve factors in the UK linkers curve. We find that a home factor accounts for about 40 percent of the variance of the real exchange rate, and that this home factor is fully accounted for by the US specific component of the LS level factor in the US TIPs curve.
    JEL: F3
    Date: 2018–06
  3. By: Sebastian Fanelli (MIT); Ludwig Straub (MIT)
    Abstract: This paper develops a theory of foreign exchange interventions in a small open economy with limited capital mobility. Home and foreign bond markets are segmented and intermediaries are limited in their capacity to arbitrage across markets. As a result, the central bank can implement nonzero spreads by managing its portfolio. Crucially, spreads are inherently costly, over and above the standard costs from distorting households’ consumption profiles. The extra term is given by the carry-trade profits of foreign intermediaries, is convex in the spread—as more foreign intermediaries become active carry traders—and increasing in the openness of the capital account—as foreign intermediaries find it easier to take larger positions. Optimal interventions balance these costs with terms of trade benefits. We show that they lean against the wind of global capital flows to avoid excessive currency appreciation. Due to the convexity of the costs, interventions should be small and spread out, relying on credible promises (forward guidance) of future interventions. By contrast, excessive smoothing of the exchange rate path may create large spreads, inviting costly speculation. Finally, in a multi-country extension of our model, we find that the decentralized equilibrium features too much reserve accumulation and too low world interest rates, highlighting the importance of policy coordination.
    Date: 2018

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