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The Hedging Channel of Exchange Rate Determination
We document the exchange rate hedging channel that connects country-level measures of net external financial imbalances with exchange rates. In times of market distress, countries with large positive external imbalances (e.g. Japan) experience domestic currency appreciation, and crucially, forward exchange rates appreciate relatively more than the spot after adjusting for interest rate differentials. Countries with large negative foreign asset positions experience the opposite currency movements. We present a model demonstrating that exchange rate hedging coupled with intermediary constraints ...
Inflation: Drivers and Dynamics 2019 Conference Summary
To provide insights into the processes that drive inflationary dynamics, the Federal Reserve Bank of Cleveland holdsan annual conference on the topic of inflation: “Inflation: Drivers and Dynamics.” This Commentary summarizes thepapers presented at the 2019 conference.
Not so disconnected: exchange rates and the capital stock
We investigate the link between stochastic properties of exchange rates and differences in capital-output ratios across industrialized countries. To this end, we endogenize capital accumulation within a standard model of exchange rate determination with nontraded goods. The model predicts that currencies of countries that are more systemic for the world economy (countries that face particularly volatile shocks or account for a large share of world GDP) appreciate when the price of traded goods in world markets is high. These currencies are better hedges against consumption risk faced by ...
A Risk-based Theory of Exchange Rate Stabilization
We develop a novel, risk-based theory of the effects of exchange rate stabilization. In our model, the choice of exchange rate regime allows policymakers to make their currency, and by extension, the firms in their country, a safer investment for international investors. Policies that induce a country's currency to appreciate when the marginal utility of international investors is high lower the required rate of return on the country's currency and increase the world-market value of domestic firms. Applying this logic to exchange rate stabilizations, we find a small economy stabilizing its ...
A Financial New Keynesian Model
This paper solves a standard New Keynesian model in terms of risk-neutral expectations and estimates it using a cross-section of longer-dated financial assets at a single point in time. Inflation risk premia appear in the theory and cause inflation to deviate from its target on average. We re-estimate the model based on each day’s closing prices to capture high-frequency changes in the expected path of the economy. Our estimates show that financial markets reacted to the post-COVID surge in inflation with higher short-run inflation expectations, an increase in the inflation risk premium, ...