Liability dollarization and the bank balance sheet channel |
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Authors: | Woon Gyu Choi David Cook |
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Institution: | a IMF Institute, International Monetary Fund, 700 19th Street, N.W., Washington, DC, USA b Department of Economics, Hong Kong University of Science and Technology, Clear Water Bay, Kowloon, Hong Kong SAR, Hong Kong |
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Abstract: | Emerging markets' financial institutions often face a mismatch in the currency denominations of their liabilities (foreign currency-denominated debt raised from foreign lenders) and their assets (domestic currency loans to domestic borrowers). We study the effect of this mismatch on monetary policy in a sticky-price, dynamic general-equilibrium small open economy model in which the country default-risk premium depends on domestic banks' balance sheets due to asymmetric information. A fixed exchange rate rule that stabilizes bank balance sheets offers greater stability than does an interest rate rule that targets inflation to offset the real effects of sticky-prices. |
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Keywords: | Bank balance sheet channel Foreign currency debt Sticky-prices Exchange rate depreciation |
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