Brauning and Ivashina (2017a) – U.S. Monetary Policy and Emerging Market Credit Cycles
This paper argues for the following chain of events:
- Federal Reserve lowers interest rates (loosens monetary policy)
- Global banks’ dollar funding costs fall
- Global banks charge lower interest rates on dollar loans
- Large firms in emerging markets, who borrow a lot of dollars, borrow more
Therefore, U.S. monetary policy sets credit conditions for foreign firms.
I have a slightly richer story in mind:
- Federal Reserve lowers interest rates
- Interest rates on dollar loans fall
- Non-U.S. firms borrow more in dollars and less in other currencies
- The drop in demand reduces interest rates on non-dollar loans
Firms’ percentage of foreign assets, percentage of foreign revenue, and percentage of foreign-currency debt do not match up, leaving residual foreign-currency exposure that firms need to hedge. For example, Amgen’s 2017 annual report states that the firm has residual foreign-exchange exposure to euros, since it has more euro-denominated revenues than debts. Firms can and do hedge this exposure using derivatives, but they can also do so by taking a short position in the currency through a method: borrowing in the currency. The latter hedge involves assuming risk (albeit a risk negatively correlated with exiting firm risk), and so should be less expensive than the latter hedge, which involves selling risk. Nonfinancial firms, then, are in good position to arbitrage nominal interest-rate differences across currencies.
- compare firms’ % foreign assets to % foreign revenues to % foreign-currency debt
- by country, by industry, by size
- systematically explore firms’ use of foreign currency
- by country, by industry, by size, by currency, by MNC-vs-standalone
If firms do change currency preferences after nominal rate changes, this propagates monetary policy from one country to another. This channel is different from, but complements, the channel of Brauning and Ivashina (2017a). It would also predict that U.S. monetary loosening does not only boost the investment of EME firms that rely on dollar funding, but also boosts the investment of EME firms in countries where other firms choose to access dollar funding, even if the firm in question does not.
- Replicate Brauning and Ivashina (2017a) figure 1,
- use multiple currencies on the horizontal axis
- use foreign-currency debt, investment, and employment on the vertical axis
- repeat for different countries, industries, and firm characteristics
- financial constraint
- mismatch between foreign assets or revenues and foreign-currency debt