Monetary policy rules and foreign currency positions

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 18 October 2010

Working Paper No. 403
By Bianca De Paoli, Hande Küçük-Tuğer and Jens Søndergaard 

Using an endogenous portfolio choice model, this paper examines how different monetary policy regimes can lead to different foreign currency positions by changing the cyclical properties of the nominal exchange rate. We find that strict inflation-targeting regimes are associated with a short position in foreign currency, while the opposite is true for non inflation targeting regimes. We also explore how these different external positions affect the international transmission of monetary shocks through the valuation channel. When central banks follow inflation-targeting Taylor-type rules, valuation effects of monetary expansions are beggar-thy-self, but they are beggar-thy-neighbour in a money growth targeting regime (or when monetary policy puts weight on output stabilisation).

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