IDEAS home Printed from https://ideas.repec.org/p/hcx/wpaper/1604.html
   My bibliography  Save this paper

Exchange Rate Targeting in the Presence of Foreign Debt Obligations

Author

Listed:
  • 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
    as

    Download full text from publisher

    File URL: https://hcapps.holycross.edu/hcs/RePEc/hcx/HC1604_OCarroll_OCarroll_Peg.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Bianca De Paoli, 2009. "Monetary Policy under Alternative Asset Market Structures: The Case of a Small Open Economy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(7), pages 1301-1330, October.
    2. Aguiar, Mark & Gopinath, Gita, 2006. "Defaultable debt, interest rates and the current account," Journal of International Economics, Elsevier, vol. 69(1), pages 64-83, June.
    3. Mark Bils & Peter J. Klenow, 2004. "Some Evidence on the Importance of Sticky Prices," Journal of Political Economy, University of Chicago Press, vol. 112(5), pages 947-985, October.
    4. Maurice Obstfeld & Kenneth Rogoff, 2002. "Global Implications of Self-Oriented National Monetary Rules," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 117(2), pages 503-535.
    5. Jonathan Heathcote & Fabrizio Perri, 2013. "The International Diversification Puzzle Is Not as Bad as You Think," Journal of Political Economy, University of Chicago Press, vol. 121(6), pages 1108-1159.
    6. Taylor, John B., 1999. "The robustness and efficiency of monetary policy rules as guidelines for interest rate setting by the European central bank," Journal of Monetary Economics, Elsevier, vol. 43(3), pages 655-679, June.
    7. Ghironi, Fabio & Lee, Jaewoo & Rebucci, Alessandro, 2015. "The valuation channel of external adjustment," Journal of International Money and Finance, Elsevier, vol. 57(C), pages 86-114.
    8. Cuadra, Gabriel & Sapriza, Horacio, 2008. "Sovereign default, interest rates and political uncertainty in emerging markets," Journal of International Economics, Elsevier, vol. 76(1), pages 78-88, September.
    9. Francesca Viani, 2011. "International financial flows, real exchange rates and cross-border insurance," Working Papers 1038, Banco de España.
    10. Jorge Selaive & Vicente Tuesta, 2003. "Net foreign assets and imperfect pass-through: the consumption real exchange rate anomaly," International Finance Discussion Papers 764, Board of Governors of the Federal Reserve System (U.S.).
    11. Giancarlo Corsetti & Luca Dedola & Sylvain Leduc, 2008. "International Risk Sharing and the Transmission of Productivity Shocks," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 75(2), pages 443-473.
    12. Robert Kollmann, 2004. "Welfare Effects of a Monetary Union: The Role of Trade Openness," Journal of the European Economic Association, MIT Press, vol. 2(2-3), pages 289-301, 04/05.
    13. Jordi Galí & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 72(3), pages 707-734.
    14. Ozge Senay & Alan Sutherland, 2015. "Local Currency Pricing, Foreign Monetary Shocks and Exchange Rate Policy," Open Economies Review, Springer, vol. 26(4), pages 633-661, September.
    15. Pierre-Olivier Gourinchas, 2008. "Valuation Effects and External Adjustment: A Review," Central Banking, Analysis, and Economic Policies Book Series, in: Kevin Cowan & Sebastián Edwards & Rodrigo O. Valdés & Norman Loayza (Series Editor) & Klaus Schmidt- (ed.),Current Account and External Financing, edition 1, volume 12, chapter 6, pages 195-236, Central Bank of Chile.
    16. Michael B. Devereux & Charles Engel, 2003. "Monetary Policy in the Open Economy Revisited: Price Setting and Exchange-Rate Flexibility," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 70(4), pages 765-783.
    17. Schmitt-Grohe, Stephanie & Uribe, Martin, 2003. "Closing small open economy models," Journal of International Economics, Elsevier, vol. 61(1), pages 163-185, October.
    18. Christiano, Lawrence J. & Trabandt, Mathias & Walentin, Karl, 2011. "Introducing financial frictions and unemployment into a small open economy model," Journal of Economic Dynamics and Control, Elsevier, vol. 35(12), pages 1999-2041.
    19. Schmitt-Grohe, Stephanie & Uribe, Martin, 2007. "Optimal simple and implementable monetary and fiscal rules," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1702-1725, September.
    20. Guillermo A. Calvo & Carmen M. Reinhart, 2002. "Fear of Floating," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 117(2), pages 379-408.
    21. Ozge Senay & Alan Sutherland, 2014. "Endogenous price flexibility and optimal monetary policy," Oxford Economic Papers, Oxford University Press, vol. 66(4), pages 1121-1144.
    22. Philip R. Lane & Gian Maria Milesi-Ferretti, 2002. "Long-Term Capital Movements," NBER Chapters, in: NBER Macroeconomics Annual 2001, Volume 16, pages 73-136, National Bureau of Economic Research, Inc.
    23. Katrin Rabitsch, 2012. "The Role of Financial Market Structure and the Trade Elasticity for Monetary Policy in Open Economies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(4), pages 603-629, June.
    24. Coeurdacier, Nicolas & Kollmann, Robert & Martin, Philippe, 2010. "International portfolios, capital accumulation and foreign assets dynamics," Journal of International Economics, Elsevier, vol. 80(1), pages 100-112, January.
    25. Mykhaylova Olena & Staveley-O’Carroll James, 2014. "International transmission of productivity shocks with nonzero net foreign debt," The B.E. Journal of Macroeconomics, De Gruyter, vol. 14(1), pages 579-624, January.
    26. Corsetti, Giancarlo & Pesenti, Paolo, 2005. "International dimensions of optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 281-305, March.
    27. Selim Elekdag & Alejandro Justiniano & Ivan Tchakarov, 2006. "An Estimated Small Open Economy Model of the Financial Accelerator," IMF Staff Papers, Palgrave Macmillan, vol. 53(2), pages 1-2.
    28. repec:hal:spmain:info:hdl:2441/c8dmi8nm4pdjkuc9g7084aa4m is not listed on IDEAS
    29. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Solving dynamic general equilibrium models using a second-order approximation to the policy function," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 755-775, January.
    30. Ozge Senay, 2008. "Interest Rate Rules And Welfare In Open Economies," Scottish Journal of Political Economy, Scottish Economic Society, vol. 55(3), pages 300-329, July.
    31. Cole, Harold L. & Obstfeld, Maurice, 1991. "Commodity trade and international risk sharing : How much do financial markets matter?," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 3-24, August.
    32. José Manuel Campa & Linda S. Goldberg, 2005. "Exchange Rate Pass-Through into Import Prices," The Review of Economics and Statistics, MIT Press, vol. 87(4), pages 679-690, November.
    33. Senay, Ozge & Sutherland, Alan, 2019. "Optimal monetary policy, exchange rate misalignments and incomplete financial markets," Journal of International Economics, Elsevier, vol. 117(C), pages 196-208.
    34. Bénétrix, Agustin S. & Lane, Philip R. & Shambaugh, Jay C., 2015. "International currency exposures, valuation effects and the global financial crisis," Journal of International Economics, Elsevier, vol. 96(S1), pages 98-109.
    35. Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2010. "Optimal Monetary Policy in Open Economies," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 16, pages 861-933, Elsevier.
    36. Pierpaolo Benigno, 2009. "Price Stability with Imperfect Financial Integration," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(s1), pages 121-149, February.
    37. V. V Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2002. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 69(3), pages 533-563.
    38. Giancarlo Corsetti & Paolo Pesenti, 2001. "Welfare and Macroeconomic Interdependence," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 116(2), pages 421-445.
    39. Benigno, Gianluca & Benigno, Pierpaolo, 2006. "Designing targeting rules for international monetary policy cooperation," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 473-506, April.
    40. Adolfson, Malin & Laseen, Stefan & Linde, Jesper & Villani, Mattias, 2007. "Bayesian estimation of an open economy DSGE model with incomplete pass-through," Journal of International Economics, Elsevier, vol. 72(2), pages 481-511, July.
    41. Wang, Jian, 2010. "Home bias, exchange rate disconnect, and optimal exchange rate policy," Journal of International Money and Finance, Elsevier, vol. 29(1), pages 55-78, February.
    42. Gianluca Benigno & Pierpaolo Benigno, 2003. "Price Stability in Open Economies," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 70(4), pages 743-764.
    43. Olivier Blanchard & Francesco Giavazzi & Filipa Sa, 2005. "International Investors, the U.S. Current Account, and the Dollar," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 36(1), pages 1-66.
    44. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1.
    45. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange rates and financial fragility," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 329-368.
    46. Enders, Zeno & Müller, Gernot J., 2009. "On the international transmission of technology shocks," Journal of International Economics, Elsevier, vol. 78(1), pages 45-59, June.
    47. 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.
    48. Senay, Ozge & Sutherland, Alan, 2013. "The Timing Of Asset Trade And Optimal Policy In Dynamic Open Economies," Macroeconomic Dynamics, Cambridge University Press, vol. 17(8), pages 1543-1573, December.
    49. Pierre-Olivier Gourinchas & Hélène Rey, 2007. "From World Banker to World Venture Capitalist: US External Adjustment and the Exorbitant Privilege," NBER Chapters, in: G7 Current Account Imbalances: Sustainability and Adjustment, pages 11-66, National Bureau of Economic Research, Inc.
    50. Michael Woodford, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(s1), pages 1-35.
    51. Senay, Ozge & Sutherland, Alan, 2016. "Country Portfolios, Collateral Constraints and Optimal Monetary Policy," CEPR Discussion Papers 11499, C.E.P.R. Discussion Papers.
    52. Stanley Fischer, 2001. "Exchange Rate Regimes: Is the Bipolar View Correct?," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 3-24, Spring.
    53. Haroon Mumtaz & Özlem Oomen & Jian Wang, 2006. "Exchange rate pass-through into UK import prices," Bank of England working papers 312, Bank of England.
    54. Cristina Arellano, 2008. "Default Risk and Income Fluctuations in Emerging Economies," American Economic Review, American Economic Association, vol. 98(3), pages 690-712, June.
    55. Eicher, Theo S. & Schubert, Stefan F. & Turnovsky, Stephen J., 2008. "Dynamic effects of terms of trade shocks: The impact on debt and growth," Journal of International Money and Finance, Elsevier, vol. 27(6), pages 876-896, October.
    56. Richard H. Clarida, 2007. "Introduction to "G7 Current Account Imbalances: Sustainability and Adjustment"," NBER Chapters, in: G7 Current Account Imbalances: Sustainability and Adjustment, pages 1-10, National Bureau of Economic Research, Inc.
    57. Benigno, Gianluca & Thoenissen, Christoph, 2008. "Consumption and real exchange rates with incomplete markets and non-traded goods," Journal of International Money and Finance, Elsevier, vol. 27(6), pages 926-948, October.
    58. Jens Sondergaard & Pietro Cova, 2004. "When Should Monetary Policy Target The Exchange Rate?," Royal Economic Society Annual Conference 2004 51, Royal Economic Society.
    59. Levy-Yeyati, Eduardo & Sturzenegger, Federico, 2005. "Classifying exchange rate regimes: Deeds vs. words," European Economic Review, Elsevier, vol. 49(6), pages 1603-1635, August.
    60. repec:ebl:ecbull:v:5:y:2007:i:6:p:1-14 is not listed on IDEAS
    61. Carmen M. Reinhart, 2000. "The Mirage of Floating Exchange Rates," Annual Proceedings, The Association for the Study of the Cuban Economy, vol. 10.
    62. Collard, Fabrice & Juillard, Michel, 2001. "Accuracy of stochastic perturbation methods: The case of asset pricing models," Journal of Economic Dynamics and Control, Elsevier, vol. 25(6-7), pages 979-999, June.
    63. Mykhaylova Olena, 2011. "Welfare Implications of Regional Asymmetries in a Monetary Union," The B.E. Journal of Macroeconomics, De Gruyter, vol. 11(1), pages 1-43, December.
    64. Vincent Bouvatier, 2007. "Are International Interest Rate Differentials Driven by the Risk Premium? The Case of Asian Countries," Economics Bulletin, AccessEcon, vol. 5(6), pages 1-14.
    65. repec:hal:wpspec:info:hdl:2441/c8dmi8nm4pdjkuc9g7084aa4m is not listed on IDEAS
    66. Canzoneri, Matthew B. & Cumby, Robert E. & Diba, Behzad T., 2005. "The need for international policy coordination: what's old, what's new, what's yet to come?," Journal of International Economics, Elsevier, vol. 66(2), pages 363-384, July.
    67. Devereux, Michael B. & Engel, Charles, 2007. "Expenditure switching versus real exchange rate stabilization: Competing objectives for exchange rate policy," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2346-2374, November.
    68. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 123(4), pages 1415-1464.
    69. Demirel Ufuk D, 2009. "The Transmission of Foreign Interest Rate Shocks to a Small-Open Economy: The Role of External Debt and Financial Integration," The B.E. Journal of Macroeconomics, De Gruyter, vol. 9(1), pages 1-37, February.
    70. Matthew B. Canzoneri & Robert E. Cumby & Behzad T. Diba, 2007. "The Cost of Nominal Rigidity in NNS Models," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(7), pages 1563-1586, October.
    71. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Staveley-O’Carroll, James & Staveley-O’Carroll, Olena M., 2017. "Impact of pension system structure on international financial capital allocation," European Economic Review, Elsevier, vol. 95(C), pages 1-22.
    2. Zahir Mohamed Omar & Mohamed Isse Ibrahim, 2021. "Determinants of External Debt: The Case of Somalia," Asian Development Policy Review, Asian Economic and Social Society, vol. 9(1), pages 33-43, March.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Mykhaylova Olena & Staveley-O’Carroll James, 2014. "International transmission of productivity shocks with nonzero net foreign debt," The B.E. Journal of Macroeconomics, De Gruyter, vol. 14(1), pages 579-624, January.
    2. Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2010. "Optimal Monetary Policy in Open Economies," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 16, pages 861-933, Elsevier.
    3. Gong, Liutang & Wang, Chan & Zou, Heng-fu, 2016. "Optimal monetary policy with international trade in intermediate inputs," Journal of International Money and Finance, Elsevier, vol. 65(C), pages 140-165.
    4. Katrin Rabitsch, 2012. "The Role of Financial Market Structure and the Trade Elasticity for Monetary Policy in Open Economies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(4), pages 603-629, June.
    5. 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.
    6. Wang, Jian, 2010. "Home bias, exchange rate disconnect, and optimal exchange rate policy," Journal of International Money and Finance, Elsevier, vol. 29(1), pages 55-78, February.
    7. Forlati, Chiara, 2015. "On the benefits of a monetary union: Does it pay to be bigger?," Journal of International Economics, Elsevier, vol. 97(2), pages 448-463.
    8. Mykhaylova, Olena, 2010. "Optimal Monetary Policy with Non-Zero Net Foreign Wealth," MPRA Paper 23598, University Library of Munich, Germany.
    9. Bianca De Paoli, 2009. "Monetary Policy under Alternative Asset Market Structures: The Case of a Small Open Economy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(7), pages 1301-1330, October.
    10. Pierpaolo Benigno, 2009. "Price Stability with Imperfect Financial Integration," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(s1), pages 121-149, February.
    11. Bianca De Paoli, 2009. "Monetary Policy under Alternative Asset Market Structures: The Case of a Small Open Economy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(7), pages 1301-1330, October.
    12. Gianluca Benigno & Bianca De Paoli, 2010. "On the International Dimension of Fiscal Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(8), pages 1523-1542, December.
    13. Corsetti, G. & Dedola, L. & Leduc, S., 2018. "Exchange Rate Misalignment, Capital Flows, and Optimal Monetary Policy Trade-offs," Cambridge Working Papers in Economics 1822, Faculty of Economics, University of Cambridge.
    14. Giancarlo Corsetti & Paolo Pesenti, 2009. "The Simple Geometry of Transmission and Stabilization in Closed and Open Economies," NBER Chapters, in: NBER International Seminar on Macroeconomics 2007, pages 65-116, National Bureau of Economic Research, Inc.
    15. Alan Sutherland, 2002. "International monetary policy coordination and financial market integration," International Finance Discussion Papers 751, Board of Governors of the Federal Reserve System (U.S.).
    16. Chan Wang & Heng-fu Zou, 2013. "Optimal monetary policy in open economies: the role of reference currency in vertical production and trade," CEMA Working Papers 586, China Economics and Management Academy, Central University of Finance and Economics.
    17. Konstantin Egorov & Dmitry Mukhin, 2020. "Optimal Policy under Dollar Pricing," Working Papers w0261, New Economic School (NES).
    18. Corsetti, Giancarlo & Dedola, Luca & Leduc, Sylvain, 2023. "Exchange rate misalignment and external imbalances: What is the optimal monetary policy response?," Journal of International Economics, Elsevier, vol. 144(C).
    19. Ester Faia & Tommaso Monacelli, 2008. "Optimal Monetary Policy in a Small Open Economy with Home Bias," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(4), pages 721-750, June.
    20. Lombardo, Giovanni & Ravenna, Federico, 2014. "Openness and optimal monetary policy," Journal of International Economics, Elsevier, vol. 93(1), pages 153-172.

    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

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:hcx:wpaper:1604. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Victor Matheson (email available below). General contact details of provider: https://edirc.repec.org/data/deholus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.