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Financial integration and the wealth effect of exchange rate fluctuations

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Author Info
Cedric Tille

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Abstract

A growing body of research emphasizes the direct impact of exchange rate movements on the value of U.S. foreign assets. Because a substantial amount of U.S. assets are denominated in foreign currencies, a depreciation of the dollar leads to large capital gains. First, we present a detailed decomposition of the U.S. balance sheet, which exhibits substantial leverage in terms of currencies and across asset categories. The United States holds 50 percent of GDP in foreign-currency assets and is long in FDI (foreign direct investment) and equity positions and short in debt and banking positions. Then, we incorporate these features of international financial integration in a simple general equilibrium model and analyze how they affect the international transmission of monetary shocks. We find that financial integration is a central component of the model, with the valuation gains from an exchange rate depreciation leading to a welfare effect that is at least as large as that stemming from nominal rigidities alone but possibly much larger. We characterize how interdependence is affected by the composition of the portfolio across asset categories and how structural features of the model interact with financial integration.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 226.

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Date of creation: 2005
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Handle: RePEc:fip:fednsr:226

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Keywords: Foreign exchange Macroeconomics International finance

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This paper has been announced in the following NEP Reports: References listed on IDEAS
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  1. Betts, Caroline & Devereux, Michael B., 2000. "Exchange rate dynamics in a model of pricing-to-market," Journal of International Economics, Elsevier, vol. 50(1), pages 215-244, February. [Downloadable!] (restricted)
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  3. Maurice Obstfeld & Kenneth Rogoff, 2005. "The unsustainable U.S. current account position revisited," Proceedings, Federal Reserve Bank of San Francisco, issue Feb. [Downloadable!]
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  4. Bekaert, Geert & Hodrick, Robert J, 1992. " Characterizing Predictable Components in Excess Returns on Equity and Foreign Exchange Markets," Journal of Finance, American Finance Association, vol. 47(2), pages 467-509, June. [Downloadable!] (restricted)
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  5. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," CEPR Discussion Papers 1131, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  6. Philip Lane & Gian Maria Milesi-Ferretti, 2005. "A Global Perspective on External Positions," The Institute for International Integration Studies Discussion Paper Series iiisdp079, IIIS. [Downloadable!]
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  7. Jonathan Heathcote & Fabrizio Perri, 2004. "The international diversification puzzle is not as bad as you think," 2004 Meeting Papers 152, Society for Economic Dynamics.
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  8. Michael Kouparitsas, 2004. "How worrisome is the U.S. net foreign debt position?," Chicago Fed Letter, Federal Reserve Bank of Chicago, issue May. [Downloadable!]
  9. Maurice Obstfeld, 2004. "External Adjustment," NBER Working Papers 10843, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  10. Luis Felipe Cespedes & Roberto Chang & Andres Velasco, 2000. "Balance Sheets and Exchange Rate Policy," NBER Working Papers 7840, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  11. Fabio Ghironi & Jaewoo Lee & Alessandro Rebucci, 2007. "The Valuation Channel of External Adjustment," NBER Working Papers 12937, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear Of Floating," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 379-408, May. [Downloadable!] (restricted)
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  13. John D. Burger & Francis E. Warnock, 2004. "Foreign participation in local-currency bond markets," International Finance Discussion Papers 794, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  14. Michele Cavallo & Cédric Tille, 2006. "Current account adjustment with high financial integration: a scenario analysis," Economic Review, Federal Reserve Bank of San Francisco, pages 31-45. [Downloadable!]
  15. Ivan Tchakarov & Selim Elekdag, 2004. "Balance Sheets, Exchange Rate Policy, and Welfare," IMF Working Papers 04/63, International Monetary Fund. [Downloadable!]
  16. Andres Velasco & Roberto Chang, 2004. "Monetary Policy and the Currency Denomination of Debt: A Tale of Two Equilibria," NBER Working Papers 10827, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  17. Michele Cavallo & Fabio Ghironi, 2000. "Net Foreign Assets and the Exchange Rate: Redux Revived," Boston College Working Papers in Economics 505, Boston College Department of Economics, revised 01 Feb 2002. [Downloadable!]
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  18. Charles Engel & Akito Matsumoto, 2005. "Portfolio Choice in a Monetary Open-Economy DSGE Model," IMF Working Papers 05/165, International Monetary Fund. [Downloadable!]
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  19. Hau, Harald, 2000. "Exchange rate determination: The role of factor price rigidities and nontradeables," Journal of International Economics, Elsevier, vol. 50(2), pages 421-447, April. [Downloadable!] (restricted)
  20. Corsetti, Giancarlo & Pesenti, Paolo, 2005. "International dimensions of optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 281-305, March. [Downloadable!] (restricted)
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  21. Gian Maria Milesi-Ferretti, & Philip R. Lane, 2003. "International Financial Integration," The Institute for International Integration Studies Discussion Paper Series iiisdp03, IIIS. [Downloadable!]
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  22. Kraay, Aart & Loayza, Norman & Serven, Luis & Ventura, Jaume, 2004. "Country Portfolios," Policy Research Working Paper Series 3320, The World Bank. [Downloadable!]
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  23. Pierre-Olivier Gourinchas & Hélène Rey, 2005. "International Financial Adjustment," International Finance 0505004, EconWPA. [Downloadable!]
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  24. Fabio Ghironi & Talan B. Iscan & Alessandro Rebucci, 2005. "Net Foreign Asset Positions and Consumption Dynamics in the International Economy," IMF Working Papers 05/82, International Monetary Fund. [Downloadable!]
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  25. Cedric Tille, 2003. "The impact of exchange rate movements on U.S. foreign debt," Current Issues in Economics and Finance, Federal Reserve Bank of New York, issue Jan. [Downloadable!]
  26. Robert Kollmann, 2005. "International Asset Portfolios: A Dynamic General Equilibrium Perspective," 2005 Meeting Papers 184, Society for Economic Dynamics.
  27. Hau, Harald & Rey, Hélène, 2003. "Exchange Rates, Equity Prices and Capital Flows," CEPR Discussion Papers 3735, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  28. Cedric Tille, 1999. "The role of consumption substitutability in the international transmission of shocks," Staff Reports 67, Federal Reserve Bank of New York. [Downloadable!]
  29. Ahearne, Alan G. & Griever, William L. & Warnock, Francis E., 2004. "Information costs and home bias: an analysis of US holdings of foreign equities," Journal of International Economics, Elsevier, vol. 62(2), pages 313-336, March. [Downloadable!] (restricted)
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  30. Matthias Doepke & Martin Schneider, 2005. "Real effects of inflation through the redistribution of nominal wealth," Staff Report 355, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  31. Olivier Blanchard & Francesco Giavazzi & Filipa Sa, 2005. "The U.S. Current Account and the Dollar," NBER Working Papers 11137, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  32. repec:tcd:wpaper:tep16 is not listed on IDEAS
  33. Roberto Chang & Andres Velasco, 2004. "Monetary policy and the currency denomination of debt: a tale of two equilibria," Pacific Basin Working Paper Series 2004-30, Federal Reserve Bank of San Francisco. [Downloadable!]
  34. repec:rus:hseeco:124089 is not listed on IDEAS
  35. Michael B. Devereux & Makoto Saito, 2006. "A Portfolio Theory of International Capital Flows," The Institute for International Integration Studies Discussion Paper Series iiisdp124, IIIS. [Downloadable!]
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  36. Benigno, Pierpaolo, 2001. "Price Stability with Imperfect Financial Integration," CEPR Discussion Papers 2854, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  37. Kenneth A. Froot, 1993. "Currency Hedging over Long Horizons," NBER Working Papers 4355, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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