nep-ifn New Economics Papers
on International Finance
Issue of 2023‒03‒27
five papers chosen by
Jiachen Zhan
University of California,Irvine

  1. The Global Dollar Cycle By Maurice Obstfeld; Haonan Zhou
  2. Central Banks as Dollar Lenders of Last Resort: Implications for Regulation and Reserve Holdings By Ms. Mitali Das; Ms. Gita Gopinath; Mr. Taehoon Kim; Jeremy C. Stein
  3. Finding the Optimal Currency Composition of Foreign Exchange Reserves with a Quantum Computer By Martin Vesely
  4. Have drivers of portfolio capital flows changed since the Global Financial Crisis? By Boonman, Tjeerd
  5. On the Effectiveness of Foreign Exchange Reserves During the 2021-22 U.S. Monetary Tightening Cycle By Rashad Ahmed; Joshua Aizenman; Jamel Saadaoui; Gazi Salah Uddin

  1. By: Maurice Obstfeld; Haonan Zhou
    Abstract: The U.S. dollar’s nominal effective exchange rate closely tracks global financial conditions, which themselves show a cyclical pattern. Over that cycle, world asset prices, leverage, and capital flows move in concert with global growth, especially influencing the fortunes of emerging and developing economies (EMDEs). This paper documents that dollar appreciation shocks predict economic downturns in EMDEs and highlights policies countries could implement to dampen the effects of dollar fluctuations. Dollar appreciation shocks themselves are highly correlated not just with tighter U.S. monetary policies, but also with measures of U.S. domestic and international dollar funding stress that themselves reflect global investors’ risk appetite. After the initial market panic and upward dollar spike at the start of the COVID-19 pandemic, the dollar fell as global financial conditions eased; but the higher inflation that followed has induced central banks everywhere to tighten monetary policies more recently. The dollar has strengthened considerably since mid-2021 and a contractionary phase of the global financial cycle is now under way. Owing to increases in public- and business-sector debts during the pandemic, a strong dollar, higher interest rates, and slower economic growth will be challenging for EMDEs.
    JEL: E58 F31 F41 F44 O11
    Date: 2023–03
  2. By: Ms. Mitali Das; Ms. Gita Gopinath; Mr. Taehoon Kim; Jeremy C. Stein
    Abstract: This paper explores how non-U.S. central banks behave when firms in their economies engage in currency mismatch, borrowing more heavily in dollars than justified by their operating exposures. We begin by documenting that, in a panel of 53 countries, central bank holdings of dollar reserves are significantly correlated with the dollar-denominated bank borrowing of their non-financial corporate sectors, controlling for a number of known covariates of reserve accumulation. We then build a model in which the central bank can deal with private-sector mismatch, and the associated risk of a domestic financial crisis, in two ways: (i) by imposing ex ante financial regulations such as bank capital requirements; or (ii) by building a stockpile of dollar reserves that allow it to serve as an ex post dollar lender of last resort. The model highlights a novel externality: individual central banks may tend to over-accumulate dollar reserves, relative to what a global planner would choose. This is because individual central banks do not internalize that their hoarding of reserves exacerbates a global scarcity of dollar-denominated safe assets, which lowers dollar interest rates and encourages firms to increase the currency mismatch of their liabilities. Relative to the decentralized outcome, a global planner may prefer stricter financial regulation (e.g., higher bank capital requirements) and reduced holdings of dollar reserves.
    Keywords: Foreign reserves; central banks; currency mismatch; lender of last resort; financial regulation; dollar reserve; bank borrowing; post dollar lender of last resort; dollar interest rates; reserve holding; International reserves; Banking crises; Currency mismatches; Reserves accumulation; Exchange rates; Global
    Date: 2023–01–18
  3. By: Martin Vesely
    Abstract: Portfolio optimization is an inseparable part of strategic asset allocation at the Czech National Bank. Quantum computing is a new technology offering algorithms for that problem. The capabilities and limitations of quantum computers with regard to portfolio optimization should therefore be investigated. In this paper, we focus on applications of quantum algorithms to dynamic portfolio optimization based on the Markowitz model. In particular, we compare algorithms for universal gate-based quantum computers (the QAOA, the VQE and Grover adaptive search), single-purpose quantum annealers, the classical exact branch and bound solver and classical heuristic algorithms (simulated annealing and genetic optimization). To run the quantum algorithms we use the IBM QuantumTM gate-based quantum computer. We also employ the quantum annealer offered by D-Wave. We demonstrate portfolio optimization on finding the optimal currency composition of the CNB's FX reserves. A secondary goal of the paper is to provide staff of central banks and other financial market regulators with literature on quantum optimization algorithms, because financial firms are active in finding possible applications of quantum computing.
    Keywords: Foreign exchange reserves, portfolio optimization, quadratic unconstrained binary optimization, quantum computing
    JEL: C61 C63 G11
    Date: 2023–02
  4. By: Boonman, Tjeerd
    Abstract: The Global Financial Crisis had a substantial impact on the size and composition of portfolio capital flows, which raises the question whether the factors driving these capital flows have changed. The literature is scarce and shows mixed results, which may be attributable to the time windows used to compare the periods before and especially after the crisis. I identify and compare robust drivers of portfolio capital inflows for 75 countries in two non-overlapping periods (1996–2007 and 2011–19) using the Bayesian Model Averaging method. I find that the drivers have changed since the crisis. Bond investors in advanced and emerging economies have become more prudent, while investors in emerging market equity search for return. After the crisis, the more advanced economies continue to capture more portfolio inflows, which confirms the Lucas paradox, and is driven by institutions rather than capital openness.
    Keywords: Portfolio Capital Flows, Bayesian Model Averaging
    JEL: C11 F32 G15
    Date: 2023–01–30
  5. By: Rashad Ahmed; Joshua Aizenman; Jamel Saadaoui; Gazi Salah Uddin
    Abstract: This paper examines the role of foreign exchange (FX) reserves and other fundamental factors in explaining cross-country differences in foreign currency depreciation observed over the 2021-22 Federal Reserve monetary policy tightening cycle that led to a sharp appreciation of the US dollar. Using a broad cross-section of over 50 countries, we document that an additional 10 percentage points of FX reserves/GDP held ex-ante was associated with 1.5 to 2 percent less exchange rate depreciation. We also find that higher ex-ante policy rates were associated with less depreciation, especially among financially open economies. Taken together, these results support the buffering role of FX reserves and their potential to promote monetary policy independence in the presence of global spillovers.
    JEL: F32 F40 F68
    Date: 2023–02

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