Working Paper: NBER ID: w28585
Authors: Joshua Aizenman; Hiro Ito; Gurnain Kaur Pasricha
Abstract: Facing acute strains in the offshore dollar funding markets during the COVID-19 crisis, the Federal Reserve (Fed) implemented measures to provide US dollar liquidity through swap arrangements with other central banks and establishing a repo facility for financial institutions and monetary authorities (FIMA) in March 2020. This paper assesses motivations for the Fed liquidity lines, and the effects and spillovers of US dollar auctions by central banks. We find that the access to the liquidity arrangements was driven by the recipient economies’ close financial and trade ties with the US. Access to dollar liquidity also reflected global trade exposure. We find that announcements of expansion of Fed liquidity facilities or of auctions using these facilities led to appreciation of partner currencies against the US dollar. and reduced deviations from covered interest parity (CIP). Dollar auctions by major central banks (BoE, ECB, BoJ and SNB) led to temporary appreciation of other currencies against the US dollar, reduced CIP deviations, and persistently reduced sovereign bond yields of other economies. However, dollar auctions done by other central banks with access to Fed facilities did not have a meaningful impact on key domestic financial variables . The impact of major central bank auctions does not differ by the economies’ financial or trade links with the US or their balance sheet currency exposure, i.e. the major central bank auctions benefitted even the more vulnerable economies.
Keywords: Central Banks; Liquidity; COVID-19; Dollar Auctions; Financial Stability
JEL Codes: F15; F21; F32; F36; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Close financial and trade ties with the US (P33) | Access to Fed liquidity arrangements (E52) |
| Announcements of Fed liquidity expansions (E52) | Appreciation of partner currencies against the US dollar (F31) |
| Dollar auctions by major central banks (F33) | Temporary appreciation of other currencies (F31) |
| Dollar auctions by major central banks (F33) | Reduced deviations from covered interest parity (CIP) (F31) |
| Demand for US dollar auctions (E41) | Ongoing stress in domestic markets (F65) |
| Economies facing appreciation pressures (F31) | Likely to auction more dollars (D44) |
| Dollar auctions by smaller central banks with Fed access (E52) | No meaningful impact on domestic financial variables (E49) |