Financial Intermediation, Exchange Rates, and Unconventional Policy in an Open Economy
This paper develops an open economy model in which financial intermediation is subject to occasionally binding collateral constraints, and uses the model to study unconventional policies such as credit facilities and foreign exchange intervention. The model highlights the interaction between the real exchange rate, interest rates, and financial frictions. The exchange rate can affect the financial intermediaries' international credit limit via a net worth effect and a leverage ratio effect; the latter is novel and depends on the equilibrium link between exchange rates and interest spreads. Unconventional policies are nonneutral if and only if financial constraints are binding in equilibrium. Credit programs are more effective if targeted towards financial intermediaries rather than the corporate sector. Sterilized foreign exchange interventions matter because the increased availability of tradables, resulting from the sterilizing credit, can relax financial frictions; this perspective is new in the literature. Finally, self fulfilling expectations can lead to the coexistence of financially constrained and unconstrained equilibria, justifying a policy of defending the exchange rate and the accumulation of international reserves.
We are indebted to participants of the Seventh Workshop of the Latin-American Finance Network, participants of seminars at the London Business School, the University of Maryland, and the Central Bank of Peru and especially Gian María Milesi-Ferretti and Anton Korinek, for insightful comments on a previous version which circulated with the title "Exchange Market Intervention as Unconventional Monetary Policy". The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Financial Intermediation, Real Exchange Rates, and Unconventional Policies in an Open Economy, Luis Felipe Céspedes, Roberto Chang, Andrés Velasco. in NBER International Seminar on Macroeconomics 2016, Clarida, Reichlin, and Devereux. 2017
Luis Felipe Céspedes & Roberto Chang & Andrés Velasco, 2017. "Financial intermediation, real exchange rates, and unconventional policies in an open economy," Journal of International Economics, vol 108, pages S76-S86.