Working Paper: NBER ID: w30787
Authors: Mitali Das; Gita Gopinath; Taehoon Kim; Jeremy C. Stein
Abstract: This paper explores how non-U.S. central banks behave when firms in their economies engage in currency mismatch, borrowing more heavily in dollars than justified by their operating exposures. We begin by documenting that, in a panel of 53 countries, central bank holdings of dollar reserves are significantly correlated with the dollar-denominated bank borrowing of their non-financial corporate sectors, controlling for a number of known covariates of reserve accumulation. We then build a model in which the central bank can deal with private-sector mismatch, and the associated risk of a domestic financial crisis, in two ways: (i) by imposing ex ante financial regulations such as bank capital requirements; or (ii) by building a stockpile of dollar reserves that allow it to serve as an ex post dollar lender of last resort. The model highlights a novel externality: individual central banks may tend to over-accumulate dollar reserves, relative to what a global planner would choose. This is because individual central banks do not internalize that their hoarding of reserves exacerbates a global scarcity of dollar-denominated safe assets, which lowers dollar interest rates and encourages firms to increase the currency mismatch of their liabilities. Relative to the decentralized outcome, a global planner may prefer stricter financial regulation (e.g., higher bank capital requirements) and reduced holdings of dollar reserves.
Keywords: central banks; dollar reserves; currency mismatch; financial regulation; lender of last resort
JEL Codes: E42; F4; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| central bank holdings of dollar reserves (E58) | dollar-denominated borrowing of the non-financial corporate sector (F34) |
| increased dollar reserves by central banks (F31) | reduced dollar interest rates (E43) |
| reduced dollar interest rates (E43) | increased currency mismatch by firms (F31) |
| central bank holdings of dollar reserves (E58) | increased currency mismatch by firms (F31) |