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Monetary Policy Rules and Foreign Currency Positions

  • Bianca De Paoli
  • Hande Küçük-Tuger
  • Jens Søndergaard

Using an endogenous portfolio choice model, this paper examines how different monetary policy regimes can lead to different foreign currency positions by changing the cyclical properties of the nominal exchange rate. We find that strict inflation targeting regimes are associated with a short position in foreign currency, while the opposite is true for noninflation targeting regimes. We also explore how these different external positions affect the international transmission of monetary shocks through the valuation channel. When central banks follow inflation targeting Taylor-type rules, valuation effects of monetary expansions are beggar-thy-self, but they are beggar-thy-neighbour in a money growth targeting regime (or when monetary policy puts weight on output stabilization).

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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp1022.

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Date of creation: Nov 2010
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Handle: RePEc:cep:cepdps:dp1022
Contact details of provider: Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

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  1. Nicolas Coeurdacier & Robert Kollmann & Philippe Martin, 2007. "International Portfolios with Supply, Demand and Redistributive Shocks," NBER Working Papers 13424, National Bureau of Economic Research, Inc.
  2. Coeurdacier, Nicolas & Kollmann, Robert Miguel W. K. & Martin, Philippe J., 2008. "International portfolios, capital accumulation and foreign assets dynamics," Discussion Paper Series 1: Economic Studies 2008,19, Deutsche Bundesbank, Research Centre.
  3. Vincent Labhard & Gabriel Sterne & Chris Young, 2005. "Wealth and consumption: an assessment of the international evidence," Bank of England working papers 275, Bank of England.
  4. Jonathan Heathcote & Fabrizio Perri, 2007. "The International Diversification Puzzle Is Not As Bad As You Think," NBER Working Papers 13483, National Bureau of Economic Research, Inc.
  5. Corsetti, Giancarlo & Pesenti, Paolo & Roubini, Nouriel & Tille, Cedric, 2000. "Competitive devaluations: toward a welfare-based approach," Journal of International Economics, Elsevier, vol. 51(1), pages 217-241, June.
  6. Matthew Higgins & Thomas Klitgaard & Cédric Tille, 2006. "Borrowing without debt? Understanding the U.S. international investment position," Staff Reports 271, Federal Reserve Bank of New York.
  7. Bianca De Paoli, 2004. "Monetary Policy and Welfare in a Small Open Economy," CEP Discussion Papers dp0639, Centre for Economic Performance, LSE.
  8. Astley, Mark & Giese, Julia & Hume, Michael & Kubelec, Chris, 2009. "Global imbalances and the financial crisis," Bank of England Quarterly Bulletin, Bank of England, vol. 49(3), pages 178-190.
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