Working Paper: NBER ID: w31937
Authors: Philippe Bacchetta; J Scott Davis; Eric Van Wincoop
Abstract: Since 2007, an increase in risk or risk aversion has resulted in a US dollar appreciation and greater deviations from covered interest parity (CIP). In contrast, prior to 2007, risk had no impact on the dollar, and CIP held. To explain these phenomena, we develop a two-country model featuring (i) market segmentation, (ii) limited CIP arbitrage (since 2007), (iii) global dollar dominance. During periods of heightened global financial stress, dollar shortages in the offshore market emerge, leading to increased CIP deviations and a dollar appreciation. The appreciation occurs even in the absence of global dollar demand shocks. Central bank swap lines mitigate these effects.
Keywords: No keywords provided
JEL Codes: E44; F31; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increase in risk or risk aversion (D81) | appreciation of the US dollar (F31) |
| increase in risk or risk aversion (D81) | greater deviations from covered interest parity (CIP) (F31) |
| increased financial stress (G59) | dollar shortages (F31) |
| dollar shortages (F31) | increased deviations from covered interest parity (CIP) (F31) |
| dollar shortages (F31) | appreciation of the US dollar (F31) |
| central bank swap lines (F33) | alleviate dollar shortages (F31) |
| central bank swap lines (F33) | reduce deviations from covered interest parity (CIP) (F31) |
| central bank swap lines (F33) | exert downward pressure on the US dollar (F31) |