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Exchange Rates and International Finance

Paper Session

Saturday, Jan. 7, 2023 2:30 PM - 4:30 PM (CST)

Hilton Riverside, Norwich
Hosted By: Econometric Society
  • Chair: Ina Simonovska, University of California-Davis

Sterilized FX Interventions: Benefits and Risks

Lawrence Christiano
,
Northwestern University
Husnu Dalgic
,
University of Mannheim

Abstract

In recent decades central bankers in many countries use sterilized intervention to smooth exchange rate fluctuations while interest rate policy is used to meet domestic policy objectives about inflation and output. This approach to policy contemplates that central bankers in effect have two tools. We explain why it is that in standard open economy models, monetary policy makers in fact have only one tool. We discuss what extra model ingredients are required to justify the second tool, which creates the possibility of pursuing domestic and foreign objectives simultaneously. We use a small open economy model to illustrate our observations and to discuss the benefits and potential pitfalls of using the two tools, when circumstances justify the availability of both tools. In the model, there are financial shocks that shift the exchange rate and disrupt local demand by inflicting capital losses and gains on the balance sheets of investing firms. We investigate the welfare consequences of using sterilized foreign asset purchases and sales to mitigate these disruptions, by minimizing potentially disruptive interest rate changes. We also examine the risk that the central bank under-estimates the persistence of a financial market shock and that sterilized intervention leads it to run dangerously low on foreign reserves.

Economic Stabilizers in Emerging Markets: The Case for Trade Credit

Bryan Hardy
,
Bank for International Settlements
Felipe Eduardo Saffie
,
University of Virginia
Ina Simonovska
,
University of California-Davis

Abstract

We study the interplay between bank and trade credit in emerging markets. We document that small and medium-sized enterprises (SMEs) trade off bank for trade credit, while large firms are more likely to extend trade credit, especially during financial crises. We develop a model of heterogeneous firms that extend state-contingent credit to each other along supply chains for the purpose of providing insurance in the case of adverse economic shocks. The model predicts that firms obtain more trade credit the less bank credit they have available, the larger is their scale of operation, and the more-debt constrained they are relative to their trading partner. Further, more debt-constrained firms receive more state-contingent trade credit from their less-constrained partners. We validate the model’s predictions using detailed firm-level data from emerging economies. We conclude that the insurance channel of trade credit earns it a role of a macroeconomic stabilizer in emerging markets.

Exchange Rate Disconnect Revisited

Ryan Chahrour
,
Boston College
Vito Cormun
,
Santa Clara University
Pierre De Leo
,
University of Maryland
Pablo Guerron
,
Boston College
Rosen Valchev
,
Boston College

Abstract

We find that variation in expected US productivity explains more than half of G6 exchange rate fluctuations vis-a-vis the USD. Both correctly-anticipated changes in productivity and expectational “noise”, which influences expected productivity but never its realization, play an important role in driving exchange rates. Together, these disturbances account for many unconditional exchange rate patterns, including predictable excess returns, low Backus-Smith correlations, and excess volatility. Our findings suggest these famous puzzles share a common empirical origin, one that is very much connected to (expected) fundamentals.

Liability Dollarization and Exchange Rate Pass-Through

Junhyong Kim
,
Korea Development Institute
Annie Soyean Lee
,
University of Wisconsin-Madison

Abstract

With a novel dataset that combines Korean firm-level and industry-level data, we explore a balance sheet channel through which an exchange rate shock passes through to domestic producer prices. Exploiting a large devaluation episode in Korea in 1997, we document that a sector with higher foreign currency debt exposure prior to the crisis experienced a larger price increase. Building a heterogeneous firm model with working capital and financial constraints, we study the transition path upon unexpected exchange rate depreciation. Upon unexpected depreciation, firms with high foreign currency debt exposure face tighter working capital and financial constraints, which reduces investment and increases costs of production and prices. The model matches qualitatively and quantitatively the observed marginal effect of the short-term foreign currency debt ratio on the sectoral price changes. The model with the balance sheet channel only can explain around 17% of the variation in price changes across industries during the crisis. We also find that the interaction of strategic complementarity in firms’ price setting and heterogeneity in foreign currency debt holdings across firms within an industry play an important role in amplifying the price increase.
JEL Classifications
  • D8 - Information, Knowledge, and Uncertainty
  • F3 - International Finance