Date of This Version
international risk sharing, foreign debt, exchange rate policy
E52, F32, F41
We study the impact of foreign debt on the trade-off between the three open economy objectives of a central bank - international risk sharing, the need to facilitate expenditure-switching, and the incentive to tilt international prices to lower the labor effort of domestic households - in a two-country DSGE model with incomplete asset markets and deviations from the purchasing power parity. We find that at low debt levels, a Taylor rule outperforms simple targeting rules. However, the central bank can improve welfare by up to 0.25 percent of consumption via an exchange rate peg when debt-to-GDP ratio reaches 100 percent.
Working Paper Number
Staveley-O'Carroll, James and Staveley-O'Carroll, Olena M., "Exchange Rate Targeting in the Presence of Foreign Debt Obligations" (2016). Economics Department Working Papers. Paper 193.