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International Financial Architecture

Paper Session

Friday, Jan. 5, 2018 8:00 AM - 10:00 AM

Marriott Philadelphia Downtown, Grand Ballroom Salon B
Hosted By: American Economic Association
  • Chair: Yuliy Sannikov, Stanford University

International Monetary Theory: Mundell Fleming Redux

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 sector productivity risk that leads to fluctuations of prices in tradable goods and determines currency risk profiles. Agents prefer to hold their country's currency, as its value is more aligned with the price of the local consumption basket, and hold foreign currency only to hedge export risk. The value of the local currency can be very sensitive to monetary policy in the large country. However, even with an open capital account, there is a corridor within which the small country can conduct its monetary policy - the width of this corridor depends on the large country's policy.

Macroprudential Policy and Intermediation of Capital Inflows

Enrique G. Mendoza
,
University of Pennsylvania
Eugenio Rojas
,
University of Pennsylvania

Abstract

We study a model in which intermediaries in an emerging economy raise funds in global markets in units of tradable goods but lend them out in units of aggregate domestic consumption goods. These modifications alter financial amplification because price variations alter the burden of debt repayment and expectations of real-exchange-rate changes alter borrowing costs. The optimal macroprudential policy under commitment is time-inconsistent, and requires larger (smaller) policy responses when the real exchange rate appreciates (depreciates). Policies aimed at either domestic lending or foreign inflows (i.e. capital controls) are equivalent if intermediation is costless. We also study a time-consistent, conditionally-efficient regulator, and in this case, optimal policy requires separate instruments affecting domestic credit and foreign inflows.

Financial Crises and Lending of Last Resort in Open Economies

Luigi Bocola
,
Northwestern University
Guido Lorenzoni
,
Northwestern University

Abstract

We study financial panics in a small open economy with floating exchange rates. In our model, bank runs trigger a decline in domestic wealth and a currency depreciation. Runs are more likely when banks have dollar debt. Dollar debt emerges endogenously in response to the precautionary motive of domestic savers: dollar savings provide insurance against crises; so when crises are possible it becomes relatively more expensive for banks to borrow in local currency, which gives them an incentive to issue dollar debt. This feedback between aggregate risk and savers’ behavior can generate multiple equilibria, with the bad equilibrium characterized by financial dollarization and the possibility of bank runs. A domestic lender of last resort can eliminate the bad equilibrium, but interventions need to be fiscally credible. Holding foreign currency reserves hedges the fiscal position of the government and enhances its credibility, thus improving financial stability.
Discussant(s)
Enrique G. Mendoza
,
University of Pennsylvania
Yuliy Sannikov
,
Stanford University
Markus K. Brunnermeier
,
Princeton University
JEL Classifications
  • F3 - International Finance
  • E4 - Money and Interest Rates