Staff Reports
Balance Sheets, Exchange Rates, and International Monetary Spillovers
Number 849
June 2018

JEL classification: E32, E44, F41

Authors: Ozge Akinci and Albert Queralto

We use a two-country New Keynesian model with balance sheet constraints to investigate the magnitude of international spillovers of U.S. monetary policy. Home borrowers obtain funds from domestic households in domestic currency, as well as from residents of the foreign economy (the United States) in dollars. We assume agency frictions are more severe for foreign debt than for domestic deposits. As a consequence, a deterioration in domestic borrowers’ balance sheets induces a rise in the home currency’s premium and an exchange rate depreciation. We use the model to investigate how international monetary spillovers are affected by the degree of currency mismatches in balance sheets, and whether the latter make it desirable for domestic policy to target the nominal exchange rate. We find that the magnitude of spillovers is significantly enhanced by the degree of currency mismatches. Our findings also suggest that using monetary policy to stabilize the exchange rate is not necessarily more desirable with greater balance sheet mismatches and may actually exacerbate short-run exchange rate volatility.

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Ozge Akinci
I declare that I have no relevant or material financial interests that relate to the research described in this staff report.

Albert Queralto
My current employer is the Board of Governors of the Federal Reserve System. The views expressed in this article are those of the authors, and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of any other person associated with the Federal Reserve System.
Other than my employer, I have not received financial support for the research described in the article submitted.