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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
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  1. Heathcote, Jonathan & Perri, Fabrizio, 2008. "The International Diversification Puzzle is Not as Bad as You Think," CEPR Discussion Papers 6982, C.E.P.R. Discussion Papers.
  2. De Paoli, Bianca, 2009. "Monetary policy and welfare in a small open economy," Journal of International Economics, Elsevier, vol. 77(1), pages 11-22, February.
  3. 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.
  4. Coeurdacier, Nicolas & Kollmann, Robert & Martin, Philippe, 2008. "International Portfolios, Capital Accumulation and Foreign Assets Dynamics," CEPR Discussion Papers 6902, C.E.P.R. Discussion Papers.
  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. 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.
  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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