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Financial Intermediation, Exchange Rates, and Unconventional Policy in an Open Economy

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  • Luis Felipe Céspedes
  • Roberto Chang
  • Andrés Velasco

Abstract

This paper develops an open economy model in which financial intermediation is subject to occasionally binding collateral constraints, and uses the model to study unconventional policies such as credit facilities and foreign exchange intervention. The model highlights the interaction between the real exchange rate, interest rates, and financial frictions. The exchange rate can affect the financial intermediaries' international credit limit via a net worth effect and a leverage ratio effect; the latter is novel and depends on the equilibrium link between exchange rates and interest spreads. Unconventional policies are nonneutral if and only if financial constraints are binding in equilibrium. Credit programs are more effective if targeted towards financial intermediaries rather than the corporate sector. Sterilized foreign exchange interventions matter because the increased availability of tradables, resulting from the sterilizing credit, can relax financial frictions; this perspective is new in the literature. Finally, self fulfilling expectations can lead to the coexistence of financially constrained and unconstrained equilibria, justifying a policy of defending the exchange rate and the accumulation of international reserves.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18431.

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Date of creation: Oct 2012
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Handle: RePEc:nbr:nberwo:18431

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  1. Ricardo J. Caballero & Arvind Krishnamurthy, 2003. "Excessive Dollar Debt: Financial Development and Underinsurance," Journal of Finance, American Finance Association, American Finance Association, vol. 58(2), pages 867-894, 04.
  2. Lawrence Christiano & Daisuke Ikeda, 2011. "Government Policy, Credit Markets and Economic Activity," NBER Working Papers 17142, National Bureau of Economic Research, Inc.
  3. Nobuhiro Kiyotaki & John Moore, 1995. "Credit Cycles," NBER Working Papers 5083, National Bureau of Economic Research, Inc.
  4. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262150476, December.
  5. Holmström, Bengt, 2013. "Inside and Outside Liquidity," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262518536, December.
  6. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, American Economic Association, vol. 79(1), pages 14-31, March.
  7. Vasco Cúrdia & Michael Woodford, 2008. "Credit frictions and optimal monetary policy," Working Paper Research, National Bank of Belgium 146, National Bank of Belgium.
  8. Holmström, Bengt & Tirole, Jean, 1994. "Financial Intermediation, Loanable Funds and the Real Sector," IDEI Working Papers, Institut d'Économie Industrielle (IDEI), Toulouse 40, Institut d'Économie Industrielle (IDEI), Toulouse.
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Cited by:
  1. Benigno, Gianluca & Chen, Huigang & Otrok, Christopher & Rebucci, Alessandro & Young, Eric R, 2012. "Optimal Policy for Macro-Financial Stability," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9223, C.E.P.R. Discussion Papers.
  2. Bacchetta, Philippe & Benhima, Kenza & Kalantzis, Yannick, 2013. "Optimal Exchange Rate Policy in a Growing Semi-Open Economy," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9666, C.E.P.R. Discussion Papers.
  3. Bayoumi, Tamim & Saborowski, Christian, 2014. "Accounting for reserves," Journal of International Money and Finance, Elsevier, Elsevier, vol. 41(C), pages 1-29.
  4. Youssouf KIENDREBEOGO, 2013. "How Do Banking Crises Affect Bilateral Exports?," Working Papers, HAL halshs-00843009, HAL.
  5. Laura Alfaro & Fabio Kanczuk, 2013. "Carry Trade, Reserve Accumulation, and Exchange-Rate Regimes," NBER Working Papers 19098, National Bureau of Economic Research, Inc.

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