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Positive and Normative Implications of Liability Dollarization for Sudden Stops Models of Macroprudential Policy

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  • Enrique G. Mendoza
  • Eugenio I. Rojas

Abstract

"Liability dollarization,'' namely intermediation of capital inflows in units of tradables into domestic loans in units of aggregate consumption, adds three important effects driven by real-exchange-rate fluctuations that alter standard models of Sudden Stops significantly: Changes on the debt repayment burden, on the price of new debt, and on a risk-taking incentive (i.e. a negative premium on domestic debt). Under perfect foresight, the first effect makes Sudden Stops milder and multiple equilibria harder to obtain. The three effects add an ``intermediation externality'' to the macroprudential externality of standard models, which is present even without credit constraints. Optimal policy under commitment can be decentralized equally by taxing domestic credit or capital inflows, and hence capital controls as a separate instrument are not justified. This optimal policy is time-inconsistent and follows a complex, non-linear schedule. Quantitatively, an optimized pair of constant taxes on domestic debt and capital inflows makes crises slightly less likely and yields a small welfare gain, but other pairs reduce welfare sharply. For high effective debt taxes, capital controls and domestic debt taxes are again equivalent, and for low ones welfare is higher with higher taxes on domestic debt than on capital inflows.

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  • Enrique G. Mendoza & Eugenio I. Rojas, 2018. "Positive and Normative Implications of Liability Dollarization for Sudden Stops Models of Macroprudential Policy," NBER Working Papers 24336, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:24336
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    Cited by:

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    2. Flora Lutz & Leopold Zessner-Spitzenberg, 2019. "Sudden Stops and Reserve Accumulation in the Presence of International Liquidity Risk," Vienna Economics Papers 1907, University of Vienna, Department of Economics.
    3. García-Cicco, Javier, 2022. "Alternative monetary-policy instruments and limited credibility: An exploration," Latin American Journal of Central Banking (previously Monetaria), Elsevier, vol. 3(1).
    4. Javier Bianchi & Enrique Mendoza, 2020. "A Fisherian Approach to Financial Crises: Lessons from the Sudden Stops Literature," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 37, pages 254-283, August.
    5. Kuzman, Tanja & Lazarevic, Jelisaveta & Nedeljkovic, Milan, 2022. "Capital flows liberalisation and macroprudential policies: The effects on credit cycles in emerging economies," Economic Analysis and Policy, Elsevier, vol. 73(C), pages 602-619.
    6. Nakatani, Ryota, 2020. "Macroprudential policy and the probability of a banking crisis," Journal of Policy Modeling, Elsevier, vol. 42(6), pages 1169-1186.
    7. Paolo Cavallino & Boris Hofmann, 2022. "Capital flows and monetary policy trade-offs in emerging market economies," BIS Working Papers 1032, Bank for International Settlements.
    8. Boris Hofmann & Nikhil Patel & Steve Pak Yeung Wu, 2022. "Original sin redux: a model-based evaluation," BIS Working Papers 1004, Bank for International Settlements.
    9. Flora Lutz & Leopold Zessner-Spitzenberg, 2019. "Sudden Stops and Reserve Accumulation in the Presence of International Liquidity Risk," Vienna Economics Papers vie1907, University of Vienna, Department of Economics.
    10. Lutz, Flora & Zessner-Spitzenberg, Leopold, 2020. "Sudden Stops and Reserve Accumulation in the Presence of International Liquidity Risk," VfS Annual Conference 2020 (Virtual Conference): Gender Economics 224520, Verein für Socialpolitik / German Economic Association.
    11. 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.
    12. Pasricha, Gurnain K., 2022. "Estimated policy rules for capital controls," Journal of International Money and Finance, Elsevier, vol. 122(C).
    13. Ottonello, Pablo, 2021. "Optimal exchange-rate policy under collateral constraints and wage rigidity," Journal of International Economics, Elsevier, vol. 131(C).

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    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • 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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