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«Floating with a Load of FX Debt? by Tatsiana Kliatskova and Uffe Mikkelsen IMF Working Papers describe research in progress by the author(s) and are ...»

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Such reaction might be optimal given the negative implications for financial stability from excessive exchange rate movements in countries with large FX exposures. However, our findings do not allow us to corroborate optimality. Other factors such as pressure on central banks to protect important sectors in the economy (and possibly large financial and nonfinancial firms and households) where FX indebtedness is high could also be at work. One should therefore be careful about drawing policy conclusion based on the assumption that the observed policies reflect optimal monetary policy. However, theoretical literature supports that when foreign currency balance sheet mismatches are large, some exchange rate management may be the optimal central bank policy (while not necessarily a Pareto efficient equilibrium).

When the FX exposure of the non-financial private sector is high, policies to reduce it should be considered to ensure monetary policy can work effectively. The importance of FX debt in inhibiting central banks from allowing exchange rates to move freely implies that monetary policy could be overburdened by multiple goals. Our finding that FX debt financed from the domestic banking system seems to be more important suggests that policies should focus first and mainly on limiting the FX lending by the banking system. Such policies could include strengthening of supervision of FX lending by the domestic banking sector, prohibiting banks to take too large outright currency risks, higher reserve requirements for foreign currency funding, higher capital requirements and risk-weights on FX lending, and potentially outright quantity restrictions on banks’ borrowing in foreign currency. More generalized capital flow management policies – while likely effective in reducing the overall FX exposures – would be less targeted and, thus, less effective in specifically reducing the banking system FX lending.

Our analysis is based on macro level data. A highly relevant alternative approach would be to estimate the level of stress in the financial and non-financial system from exchange rate movements by using household and firm level data on FX assets, liabilities, hedging, and income. However, such micro level data is difficult to obtain on a consistent basis for several countries. More granular data from credit registries or surveys may allow for further research to shed light on the importance of foreign currency balance sheet exposures.

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whether countries with high levels of balance sheet FX exposures are more likely to choose a fixed exchange rate regime.

Finally, while we treat the decision of households and firms to borrow in FX as purely exogenous, policies to limit exchange rates movements (depreciations mainly) may incentivize increased FX borrowing as explained by Chang and Velasco (2006). Emerging market countries may be diverging towards different equilibria with some on a suboptimal path of high and increasing FX borrowing and more exchange rate management, and others on a path of low and declining FX borrowing and less exchange rate management. Studying this dual causality empirically would also be an interesting (yet challenging) extension.


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Adler, G., N. Lisack and Rui C. Mano (2015): “Unveiling the Effects of Foreign Exchange Intervention: A Panel Approach,” IMF Working Paper 15/130, International Monetary Fund.

Adler, G. and C. E. Tovar (2011): “Foreign Exchange Intervention: A Shield Against Appreciation Winds?,” IMF Working Paper 11/165, International Monetary Fund.

Advancing the Work on Foreign Currency Exposures (2015), International Monetary Fund.

Arteta, C.O. (2003): "Exchange Rate Regimes and Financial Dollarization: Does Flexibility Reduce Bank Currency Mismatches?," International Finance 0303005, EconWPA.

Basso, H.S., O. Calvo-Gonzalez and M. Jurgilas (2011): “Financial Dollarization: The Role of Foreign-Owned Banks and Interest Rates,” Journal of Banking and Finance 35, 794-806.

Benes, J., A. Berg, R.A. Portillo and D. Vavra (2013): “Modeling Sterilized Interventions and Balance Sheet Effects of Monetary Policy in a New-Keynesian Framework,” IMF Working Paper 13/11, International Monetary Fund.

Berkmen, A.P. and E. A. Cavallo (2009): Exchange Rate Policy and Liability Dollarization:

What Do the Data Reveal about Causality?,” IMF Working Paper 07/33, International Monetary Fund.

Blanchard, O., G. Adler, and I. Carvalho Filho (2015): “Can Foreign Exchange Intervention Stem Exchange Rate Pressures from Global Capital Flow Shocks?,” IMF Working Paper 15/159, International Monetary Fund.

Calvo, G.A. and C.M. Reinhart (2002): “Fear of Floating,” The Quarterly Journal of Economics Vol. CXVII, Issue 2, 379-408.

Cespedes, F.L., R. Chang and A. Velasco (2004): “Balance Sheet and Exchange Rate Policy,” The American Economic review, 94(4), 1183-1193.

Chamon, M. and R. Hausmann (2005): “Why Do Countries Borrow the Way they Borrow?,” Chapter in “Other People's Money: Debt Denomination and Financial Instability in Emerging Market Economies”, The University of Chicago Press.

Chang, R. and A. Velasco (2006): “Currency mismatches and Monetary Policy: A Tale of two Equilibria,” Journal of International Economics 69, 150-175.

Daude, C., E. Levy Yeyati, and A. Nagengast (2014): “On the Effectiveness of Exchange Rate Interventions in Emerging Markets," OECD Development Centre Working Papers 324, OECD Publishing.

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Greene. W.H. (2012): “Econometric Analysis,” Pearson Education, 7th edition, 1228 p.

Filosa, R. (2001): “Monetary Policy rules in Some Mature Emerging economies,” BIS Working Paper 8, Bank of International Settlement.

Global Financial Stability Report (2015), International Monetary Fund.

Harms, P. and M. Hoffmann (2011): "Deciding to Peg the Exchange Rate in Developing Countries: The Role of Private-Sector Debt," Open Economies Review, Springer, vol. 22(5), 825-846.

Hausman, R., U. Panizza and E. Stein (2000): “Why Do Countries Float the Way they Float?,” Working Paper 418, Inter-American Development Bank.

Honig, A. (2005): "Fear of floating and domestic liability dollarization," Emerging Markets Review, Elsevier, vol. 6(3), 289-307.

Kamil, H. (2012): “How Do Exchange rate Regimes Affect Firms’ Incentives to hedge Currency Risk? Micro Evidence for Latin America,” IMF Working Paper 12/69, International Monetary Fund.

Mohanty, M.S. amd M. Klau (2004): “Monetary Policy Rules in Emerging Market Economies: Issues and Evidence,” BIS Working Paper 149, Bank of International Settlements.

Obstfeld, M., J. C. Shambaugh, and A. M. Taylor (2010): “Financial Stability, the Trilemma, and International Reserves," American Economic Journal: Macroeconomics, 2, 57-94.

Rey, H. (2015): “Dilemma not Trilemma: The global Financial Cycle and Monetary Policy Independence, “NBER Working Paper 21162, National Bureau of Economic Research.

Roger, S., J. Restrepo and C. Garcia (2009): “Hybrid Inflation Targeting Regimes,” IMF Working Paper 09/234, International Monetary Fund.

Vegh, A. C. and G. Vuletin (2012): “Overcoming the Fear of Free Falling: Monetary Policy Graduation in Emerging Markets,” NBER Working Paper 18175, National Bureau of Economic Research.

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FCL agreement dummy -0.002*** -0.002*** (0.001) (0.001) Observations 1,897 1,897 1,407 1,407 1,897 1,897 R-squared 0.960 0.960 0.941 0.941 0.960 0.960 Robust standard errors in parentheses, *** p0.01, ** p0.05, * p0.1

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