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External shocks and FX intervention policy in financially dollarized economies

Author

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  • Carrasco, Alex
  • Florián Hoyle, David

Abstract

We examine the role of sterilized FX interventions as a monetary policy tool in response to external shocks for dollarized emerging market economies. Our model highlights an agency problem that limits banks’ ability to secure funds in both domestic and foreign currencies, with its intensity linked to currency mismatches in the banking sector. This leads to endogenous deviations from the standard UIP condition, resulting in a non-neutral FX intervention policy. Sterilized FX interventions stabilize financial conditions not only by stabilizing real exchange rates but also by acting as a balance sheet policy that directly influences credit supply. Our quantitative analysis shows that FX policy rules that counteract exchange rate deviations reduce volatility in interest rate spreads including UIP deviations, credit, investment, and output, leading to significant welfare improvements compared to a flexible exchange rate regime.

Suggested Citation

  • Carrasco, Alex & Florián Hoyle, David, 2025. "External shocks and FX intervention policy in financially dollarized economies," Journal of Macroeconomics, Elsevier, vol. 84(C).
    • Handle: RePEc:eee:jmacro:v:84:y:2025:i:c:s0164070425000096
    DOI: 10.1016/j.jmacro.2025.103672
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    More about this item

    Keywords

    FX intervention; External shocks; Monetary policy; Financial frictions; Dollarization;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles

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