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Capital Flows, Currencies, and International Arbitrage

Paper Session

Saturday, Jan. 5, 2019 8:00 AM - 10:00 AM

Hilton Atlanta, 203
Hosted By: International Economics and Finance Society
  • Chair: Linda Goldberg, Federal Reserve Bank of New York

Banking, Trade and the Making of a Dominant Currency

Gita Gopinath
Harvard University
Jeremy C. Stein
Harvard University


We explore the interplay between trade invoicing patterns and the pricing of safe assets
in different currencies. Our theory highlights the following points: 1) a currency’s role as a
unit of account for invoicing decisions is complementary to its role as a safe store of value;
2) this complementarity can lead to the emergence of a single dominant currency in trade invoicing
and global banking, even when multiple large candidate countries share similar economic
fundamentals; 3) firms in emerging-market countries endogenously take on currency
mismatches by borrowing in the dominant currency; 4) the expected return on dominant currency
safe assets is lower than that on similarly safe assets denominated in other currencies,
thereby bestowing an “exorbitant privilege” on the dominant currency. The theory thus
provides a unified explanation for why a dominant currency is so heavily used in both trade
invoicing and in global finance.

Exchange Rate Exposure and Firm Dynamics

Juliana Salomao
University of Minnesota
Liliana Varela
University of Warwick


This paper develops a heterogeneous firm-dynamics model with endogenous currency debt composition to jointly study financing and investment decisions in developing economies. In our model, firms' foreign currency borrowing arises from a trade-off between exposure to currency risk and growth. We assess econometrically the pattern of foreign currency borrowing using firm-level census data on Hungary, calibrate the model and quantify its aggregate impact. Our counterfactual exercises show that foreign currency borrowing can lead to higher growth and that the efficiency of the banking sector to screen productive and capital-scarce firms is essential to reap up the benefits of this financing.

Systematic Intervention and Currency Risk Premia

Marcel Fratzscher
DIW Berlin
Lukas Menkhoff
DIW Berlin
Lucio Sarno
City University of London
Maik Schmeling
City University of London
Tobias Stoehr
DIW Berlin


Using data for the trades of 19 central banks intervening in currency markets,
we show that leaning against the wind by individual central banks leads to “systematic
intervention” in the aggregate central banking sector. This systematic
intervention is driven by and impacts on the same factors that drive currency
excess returns: carry, momentum, value, and a dollar factor. The sensitivity
of an individual central bank’s intervention to these factors differs greatly
across countries, with developed countries making a profit from intervention
and emerging markets incurring large losses.

Macroprudential FX Regulations: Shifting the Snowbanks of FX Vulnerability?

Toni Ahnert
Bank of Canada
Kristin J. Forbes
Massachusetts Institute of Technology
Christian Friedrich
Bank of Canada
Dennis Reinhardt
Bank of England


Can macroprudential foreign exchange (FX) regulations on banks reduce the financial and
macroeconomic vulnerabilities created by borrowing in foreign currency? To evaluate the
effectiveness and unintended consequences of macroprudential FX regulation, we develop a
parsimonious model of bank and market lending in domestic and foreign currency and derive
four predictions. We confirm these predictions using a rich dataset of macroprudential FX
regulations. These empirical tests show that FX regulations: (1) are effective in terms of reducing
borrowing in foreign currency by banks; (2) have the unintended consequence of simultaneously
causing firms to increase FX debt issuance; (3) reduce the sensitivity of banks to exchange rate
movements, but (4) may not significantly reduce the sensitivity of corporates or the broader
financial market to exchange rate movements. As a result, FX regulations on banks appear to be
successful in mitigating the vulnerability of banks to exchange rates movements and the global
financial cycle, but may have the side effect of “shifting the snowbanks” of a portion of this
vulnerability to other sectors.
JEL Classifications
  • F3 - International Finance
  • F4 - Macroeconomic Aspects of International Trade and Finance