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Monetary and Macroprudential Policies under Dollar-Denominated Foreign Debt

Author

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  • Hidehiko Matsumoto

    (Economist, Institute for Monetary and Economic Studies, Bank of Japan (currently, Assistant Professor, National Graduate Institute for Policy Studies, E-mail: hmatsu.hm@gmail.com))

Abstract

This paper studies the optimal monetary and macroprudential policies in a small open economy that borrows from abroad in foreign currency. The model features a novel mechanism in which sudden stops due to an occasionally binding borrowing constraint trigger a sharp currency depreciation through balance of payments adjustments, thereby increase the domestic-currency value of foreign debt and cause severe economic downturns. A policy analysis shows that a contractionary monetary policy mitigates depreciation during a crisis, but the anticipation of policy interventions during the crisis induces larger borrowings ex ante and destabilizes the economy. A combination of an ex ante macroprudential tax on foreign borrowing and ex post monetary policy interventions can stabilize the economy and improve social welfare.

Suggested Citation

  • Hidehiko Matsumoto, 2021. "Monetary and Macroprudential Policies under Dollar-Denominated Foreign Debt," IMES Discussion Paper Series 21-E-04, Institute for Monetary and Economic Studies, Bank of Japan.
  • Handle: RePEc:ime:imedps:21-e-04
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    File URL: https://www.imes.boj.or.jp/research/papers/english/21-E-04.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Exchange rate; Balance of payments; Sudden stops; Monetary policy; Macroprudential policy;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F38 - International Economics - - International Finance - - - International Financial Policy: Financial Transactions Tax; Capital Controls
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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