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International Monetary Theory: A Risk Perspective

Author

Listed:
  • Markus K. Brunnermeier

    (Princeton University)

  • Yuliy Sannikov

    (Stanford University)

Abstract

We build a two-country model, in which currency values are endogenously determined. Risk plays a key role – including idiosyncratic risk that creates precautionary savings demand for money, and aggregate risk that creates a demand for foreign assets and affects the risk profile of the local currency. In equilibrium, different currencies can coexist, but the value of local currency is non-monotonic in the idiosyncratic risk level. With idiosyncratic risk frictions, the optimal policy can differ significantly from the competitive outcome in terms of both the net foreign asset position in dollars and the value of local currency. Dollar monetary policy can have significant spillovers on the small country both in the competitive equilibrium and under optimal policy.

Suggested Citation

  • Markus K. Brunnermeier & Yuliy Sannikov, 2019. "International Monetary Theory: A Risk Perspective," Working Papers 2019-20, Princeton University. Economics Department..
  • Handle: RePEc:pri:econom:2019-20
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    File URL: https://scholar.princeton.edu/sites/default/files/money_international6.pdf
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    More about this item

    Keywords

    Monetary Economics; Currencies; Exchange Rates; International Trade; Risk Sharing; Financial Frictions;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G01 - Financial Economics - - General - - - Financial Crises
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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