Professor Malamud's research relevant for central banks

© 2019 EPFL

© 2019 EPFL

A key news portal for central banks publishes an article about Semyon Malamud's research.
The pattern of movements in the US dollar exchange rate fits its role as the dominant global currency for debt contracts, according to research published by the Bank for International Settlements. Authors Egemen Eren and Semyon Malamud develop an international general equilibrium model to explain how the dollar’s role in debt can affect its dominance.

Because expansionary monetary policy supports debt sustainability during downturns by boosting inflation and depreciating the exchange rate, the authors say an equilibrium emerges for the dominant currency.

Investors converge on the currency that depreciates during a downturn over the average maturity of corporate debt – around seven years. The risk of default is “minimal” if debt is issued in currencies that co-move positively with firm profits.

The authors say their model fits the data. Although the dollar serves as a safe haven and therefore appreciates in a downturn, it “robustly depreciates” in line with the typical horizon of corporate liabilities.

The results have implications for US monetary policy, assuming policy-makers want to maximise global welfare, the authors say. The optimal policy might not be to maximise debt sustainability as this can encourage excessive debt accumulation.

Author: Carole Bonardi