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What’s Special About the Dollar in Financial Markets?

Paper Session

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

Pennsylvania Convention Center, 204-C
Hosted By: American Economic Association
  • Chair: Jeremy Stein, Harvard University

Exchange Rates and the Working Capital Channel of Trade Fluctuations

Valentina Bruno
,
American Universiry
Se-Jik Kim
,
Seoul National University
Hyun Song Shin
,
Bank for International Settlements

Abstract

Exchange rates affect the economy not only through the competitiveness of exports but also through a financial channel. The financial channel goes in the opposite direction to the competitiveness channel in that a stronger currency goes hand-in-hand with more buoyant real economic activity on the back of faster credit growth and cross-border banking flows. The effect is particularly marked for emerging market economies for the bilateral exchange rate against the dollar: a stronger dollar may actually lead to a decline in trade volumes of an emerging market economy. Our paper develops a stylized model that generates such an effect and finds supporting evidence in a firm-level investigation of manufacturing firms from China.

Foreign Safe Asset Demand for U.S. Treasurys and the Dollar

Zhengyang Jiang
,
Stanford University
Arvind Krishnamurthy
,
Stanford University
Hanno Lustig
,
Stanford University

Abstract

The convenience yield that foreign investors derive from holding U.S. Treasurys causes a failure of Covered Interest Rate Parity by driving a wedge between the yield on the foreign bonds and the currency-hedged yield on the U.S. Treasury bonds. Even before the 2007-2009 financial crisis, the Treasury-based dollar basis is negative and occasionally large. We use the Treasury basis as a measure of the foreign convenience yield. Consistent with the theory, an increase in the convenience yield that foreign investors impute to U.S. Treasurys coincides with an immediate appreciation of the dollar, but predicts future depreciation of the dollar. The Treasury basis variation accounts for up to 25% of the quarterly variation in the dollar between 1988 and 2017.

Trade Invoicing, Bank Funding, and Central Bank Reserve Holdings

Gita Gopinath
,
Harvard University
Jeremy Stein
,
Harvard University

Abstract

We develop a model that shows how the currency denomination of a country’s imports influences the funding structure of its banking system, and in turn, the currency composition of its central bank’s reserve holdings. The link between the dollar’s role in bank funding and its role as a central bank reserve currency is stronger when the country’s fiscal capacity is limited, and when exchange rates are volatile. In the data, there is a pronounced cross-country relationship between the fraction of imports that are dollar invoiced, and the fraction of central-bank foreign-exchange reserves that are held in dollars.
Discussant(s)
Jesse Schreger
,
Columbia University
Alexi Savov
,
New York University
Helene Rey
,
London Business School
JEL Classifications
  • F3 - International Finance
  • G2 - Financial Institutions and Services