Liability Dollarization and the Bank Balance Sheet Channel

IMF Working Papers, August 1, 2002

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Liability Dollarization and the Bank Balance Sheet Channel

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Bibliographic details

• Authors: David Cook, Woon Gyu Choi
• Published: August 1, 2002
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781451856194.001

Summary and main finding

• Banks in developing economies often face a mismatch in the currency denomination of their liabilities (foreign currency denominated debt) and assets (domestic currency loans to domestic borrowers).
• The authors study the effect of this mismatch on business cycles and monetary policy in a sticky-price, dynamic general equilibrium model of a small open economy.
• Model analysis finding:
  • A fixed exchange rate rule that stabilizes the balance sheets of banks offers greater stability than an interest rate rule that targets inflation in the sticky-price sector of the economy.

Model, scope, and themes

• Model type: sticky-price, dynamic general equilibrium model of a small open economy.
• Economic mechanisms and topics emphasized:
  • Bank balance sheet channel
  • Liability dollarization (foreign currency denominated debt vs. domestic currency assets)
  • Business cycles
  • Monetary policy rules and their effects on stability
  • Sticky prices

Policy implications and comparative policy evaluation

• Comparative result from the model:
  • Fixed exchange rate rule focused on stabilizing bank balance sheets dominates an interest rate rule that targets sticky-price inflation in terms of offering greater stability.
• Policy-relevant themes to consider:
  • Exchange rate regime choice in economies with liability dollarization.
  • Interaction between bank balance sheets and monetary policy credibility/stability.

Key publication and metadata

• Authors: David Cook, Woon Gyu Choi
• Publication date: August 1, 2002
• Series: Working Paper No. 2002/141
• Issue: 141
• Volume: 2002
• Pages: 26
• DOI: https://doi.org/10.5089/9781451856194.001
• Stock No: WPIEA1412002
• ISBN: 9781451856194
• ISSN: 1018-5941
• Subject tags: Banking, Consumption, Exchange rates, Financial statements, Foreign exchange, National accounts, Prices, Public financial management (PFM), Return on investment, Sticky prices
• Keywords: Asia and Pacific, bank balance sheet channel, capitalization ratio, Consumption, core rule, depreciation, East Asia, exchange rate, exchange rate depreciation, Exchange rates, Financial statements, foreign currency debt, Global, interest rate, interest rate rule, interest rate shock, nominal interest rate, PEG rule, Return on investment, risk premium, sticky prices, WP

Liability Dollarization and the Bank Balance Sheet Channel — IMF Working Paper No. 2002/141

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