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Exchange Rate Targeting in the Presence of Foreign Debt Obligations

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  • James Staveley-O'Carroll

    (Economics Division, Babson College)

  • Olena M. Staveley-O'Carroll

    (Department of Economics, College of the Holy Cross)

Abstract

We study the impact of foreign debt on the trade-off between the three open economy objectives of a central bank - international risk sharing, the need to facilitate expenditure-switching, and the incentive to tilt international prices to lower the labor effort of domestic households - in a two-country DSGE model with incomplete asset markets and deviations from the purchasing power parity. We fi?nd that at low debt levels, a Taylor rule outperforms simple targeting rules. However, the central bank can improve welfare by up to 0.25 percent of consumption via an exchange rate peg when debt-to-GDP ratio reaches 100 percent.

Suggested Citation

  • James Staveley-O'Carroll & Olena M. Staveley-O'Carroll, 2016. "Exchange Rate Targeting in the Presence of Foreign Debt Obligations," Working Papers 1604, College of the Holy Cross, Department of Economics.
    • Handle: RePEc:hcx:wpaper:1604
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    More about this item

    Keywords

    international risk sharing; foreign debt; exchange rate policy;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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