Essays in International Finance
Abstract
This dissertation discusses central banking as world markets become more interlinked, as the Federal Reserve generates international shocks, and as the dollar becomes more pervasive globally.In the first chapter, I establish a new fact on how the Fed's monetary policy spills over into foreign currency and bond markets asymmetrically. Using high-frequency data, I show that when the Fed tightens: (i) the dollar appreciates more against high-rate currencies (e.g. the Australian dollar) than against low-rate currencies (e.g. the yen), and (ii) high-rate long-maturity bond yields rise more than low-rate yields. Apart from the European Central Bank, other countries do not generate spillovers of their own. My results illustrate the unique potency of the Fed and the heterogeneity in global markets.
In the second chapter, I examine the channels through which the Fed's monetary policy spills over into foreign financial markets. Specifically, I show that the fact identified in the first chapter provides evidence against two leading channels of spillovers. The asymmetries across currency and bond markets reject theories in which foreign central banks react to the Fed, and reject models with full risk-sharing in which foreign risk premia shift, as currency and bond markets contradict each other under these two channels. Shifts in risk premia under models with incomplete markets are most consistent with these patterns. My results suggest that the Fed's spillovers do not diminish the independence of central banks, but rather illustrate the importance of frictions.
In the third chapter, I document and explain the accumulation of large dollar portfolios by foreign central banks, by arguing that these reserve portfolios hedge liquidity shocks to dollarized financial systems. First, I extract currency shares for the foreign reserves of seventy-seven countries. The dollar shares are large and well-explained by the dollar shares of their financial systems' liabilities, particularly for countries that cannot borrow from the Fed directly. Second, I generate a model in which central banks use dollar reserves to mitigate liquidity shocks to their dollarized financial systems, particularly when foreign exchange transaction costs are high.
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