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Foreign currency debt and the optimal monetary policy response to rising US interest rates

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  • Adam Honig

Abstract

Rising US interest rates impact emerging economies through capital outflows and currency depreciations. For those with flexible exchange rates, the appropriate monetary policy response weighs the traditional competitiveness effect with a balance sheet effect created by the presence of foreign currency denominated debt (liability dollarization). This paper presents a basic Keynesian macro model that incorporates this balance sheet effect and demonstrates that it significantly complicates the monetary policy response to depreciations. Without full knowledge of the size of these competing effects, the central bank can make large mistakes in setting interest rates.

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  • Adam Honig, 2019. "Foreign currency debt and the optimal monetary policy response to rising US interest rates," Applied Economics Letters, Taylor & Francis Journals, vol. 26(21), pages 1739-1743, December.
    • Handle: RePEc:taf:apeclt:v:26:y:2019:i:21:p:1739-1743
    DOI: 10.1080/13504851.2019.1593931
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    Cited by:

    1. Glocker, Christian & Piribauer, Philipp, 2021. "Digitalization, retail trade and monetary policy," Journal of International Money and Finance, Elsevier, vol. 112(C).

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