Your browser does not support the PubReader view.
Go to this page to see a list of supporting browsers.
Seoul Journal of Economics
[ Article ]
Seoul Journal of Economics - Vol. 28, No. 2, pp.237-264
ISSN: 1225-0279 (Print)
Print publication date 30 May 2015
Received 02 Jul 2014 Revised 22 Apr 2015 Accepted 23 Apr 2015

Forward Guidance and Financial Stability in a Model of Optimal Central Bank Swap Lines

Tack Yun
Professor, Department of Economics, Seoul National University tackyun@snu.ac.kr

JEL Classification: E31, F31, F32

Abstract

The main goal of this study is to develop a dynamic equilibrium model of central bank swap lines that helps understand the recent observed behaviors of foreign reserves and to analyze the potential effect of the Federal Reserves’ foreign exchange swap lines on the determination of international reserves and exchange rates. The model focuses on the issue of moral hazard that can arise with the liquidity provision of the Federal Reserve through its swap lines with other central banks. This study argues that a standard debt contract under asymmetric information between lenders and borrowers may not work to model actual swap lines between the Federal Reserve and foreign central banks because lenders tend to accept credit risks in debt contract models. This study shows that debt contracts between the Federal Reserve and foreign central banks are inferior to swap contracts in the presence of the informational advantage of foreign central banks for local financial institutions in their jurisdictions. Although the proposed model is primarily intended to understand the contractual relation between the Federal Reserve and foreign central banks, it can also serve as a determination model for the nominal exchange rate. A policy implication of this model is that short-run and longrun channels are available through which the expectation formation of agents is affected by the behavior of international reserves and the credible long-term stance of the monetary policy.

Keywords:

International Reserves, Exchange Rate, Central Bank Liquidity Swap Lines

Acknowledgments

I appreciate comments from participants of the summer workshop 2014 held by the SNU Institute for Research in Finance and Economics. This work was supported by the National Research Foundation of Korea Grant funded by the Korean Government (NRF-2014S1A3A2044637). All errors are my own.

References

  • Aizenman, Joshua, Yothin Jinjarak, and Donghyun Park. “International Reserves and Swap Lines: The Recent Experience.” International Review of Economics and Finance 20 (No. 1 2011): 5-18. [https://doi.org/10.1016/j.iref.2010.07.002]
  • Aizenman, Joshua, and Jaewoo Lee. “International Reserves: Precautionary Versus Mercantilist Views, Theory and Evidence.” Open Economies Review 18 (No. 2 2007): 191-214. [https://doi.org/10.1007/s11079-007-9030-z]
  • Allen, William, and Richhild Moessner. “Options for Meeting the Demand for International Liquidity during Financial Crises.” BIS Quarterly Review September (2010): 51-61.
  • Bernanke, Ben, Mark Gertler, and Simon Gilchrist. “The Financial Accelerator in a Quantitative Business Cycle Framework.” In John B. Taylor and Michael Woodford (ed.), Handbook of Macroeconomics, Chap. 21, Vol. 1-C, Amsterdam, Netherlands: Elsevier, pp. 1341-1393, 1999. [https://doi.org/10.1016/S1574-0048(99)10034-X]
  • Boivin, Jean, Michael T. Kiley, and Frederic S. Mishkin. “How Has the Monetary Transmission Mechanism Evolved Over Time?” In Benjamin M. Friedman and Michael Woodford (ed.), Handbook of Monetary Economics, Chap. 8, Vol. 1-C, Amsterdam, Netherlands: Elsevier, pp. 369-422, 2010. [https://doi.org/10.1016/B978-0-444-53238-1.00008-9]
  • Chang, Roberto, and Andres Velasco. “A Model of Financial Crises in Emerging Markets.” Quarterly Journal of Economics 116 (No. 2 2001): 489-517. [https://doi.org/10.1162/00335530151144087]
  • Chinn, Menzie, and Saad Quayyum. Long Horizon Uncovered Interest Parity Re-assessed. NBER Working Paper No. 18482 (October), 2010.
  • Dominguez, Kathryn, Yuko Hashimoto, and Takatoshi Ito. “International Reserves and the Global Financial Crisis.” Journal of International Economics 88 (2010): 388-406. [https://doi.org/10.1016/j.jinteco.2012.03.003]
  • Del Negro, Marco, Marc Giannoni, and Christina Patterson. The Forward Guidance Puzzle. Federal Reserve Bank of New York Staff Report No. 574, 2012. [https://doi.org/10.2139/ssrn.2163750]
  • Fleming, Michael, and Nicholas Klagge. “The Federal Reserve’s Foreign Exchange Swap Lines.” Current Issues in Economics and Finance 16 (No. 4 2010): 1-7. [https://doi.org/10.2139/ssrn.1597320]
  • Frankel, Jeffrey. “Monetary Policy in Emerging Markets: in Handbook of Monetary Economics.” In Benjamin Friedman and Michael Woodford (ed.), Handbook of Monetary Economics, Chap. 25, Vol. 3-B, Amsterdam, Netherlands: Elsevier, pp. 1439-1518, 2010. [https://doi.org/10.3386/w16125]
  • Farhi, Emmanuel, and Ivan Werning. Dealing with the Trilemma: Optimal Capital Controls with Fixed Exchange Rates. Unpublished Manuscript, 2013. [https://doi.org/10.3386/w18199]
  • Farhi, Emmanuel, and Ivan Werning. A Theory of Macroprudential Policies in the Presence of Nominal Rigidities. Unpublished Manuscript, 2013. [https://doi.org/10.3386/w19313]
  • Gertler, Mark, and Nobu Kiyotaki. “Financial Intermediation and Credit Policy in Business Cycle Analysis.” In Benjamin Friedman, and Michael Woodford (ed.), Handbook of Monetary Economics, Chap. 11, Vol. 3-A, Amsterdam, Netherlands: Elsevier, pp. 547-599, 2011. [https://doi.org/10.1016/B978-0-444-53238-1.00011-9]
  • Gertler, Mark, and Nobu Kiyotaki. Banking, Liquidity and Bank Runs in an Infinite Horizon Economy. Unpublished Manuscript, 2013. [https://doi.org/10.3386/w19129]
  • Kiley, Michael. Exchange Rates, Monetary Policy Statements, and Uncovered Interest Parity: Before and After the Zero Lower Bound. Finance and Economics Discussion Paper No. 2013-17, 2013. [https://doi.org/10.2139/ssrn.2246910]
  • Obstfeld, Maurice, Jay C. Shambaugh, and Alan M. Taylor. “Financial Instability, Reserves, and Central Bank Swap Lines in the Panic of 2008.” American Economic Review 99 (No. 2 2009): 480-486. [https://doi.org/10.1257/aer.99.2.480]
  • Obstfeld, Maurice, Jay C. Shambaugh, and Alan M. Taylor. “Financial Stability, the Trilemma, and International Reserves.” American Economic Journal: Macroeconomics 2 (No. 2 2010): 57-94. [https://doi.org/10.1257/mac.2.2.57]
  • Schmitt-Grohe, Stephanie, and Martin Uribe. “Downward Nominal Wage Rigidity and the Case for Temporary Inflation in the Eurozone.” Journal of Economic Perspectives 27 (No. 3 2013): 193-212. [https://doi.org/10.1257/jep.27.3.193]