Monetary and macroprudential policy with foreign currency loans

In a number of countries a substantial proportion of loans is denominated in foreign currency. In this paper we demonstrate how their presence affects the economy. To this end we construct a small open economy model with financial frictions where loans can be taken in domestic or foreign currency. The model is calibrated for Poland - a typical small open economy with a large share of foreign currency loans (FCL). We show that FCLs negatively affect the transmission of monetary policy but do not impact on the effectiveness of macroprudential policy. We also demonstrate that FCLs increase welfare when domestic interest rate shocks are strong and decrease it when risk premium (exchange rate) shocks dominate. Under a realistic calibration of the stochastic environment FCLs are welfare reducing. Finally, we show that regulatory policies that correct the share of FCLs may cause a cyclical slowdown.