The Spillovers from Easy Liquidity and the Implications for Multilateralism

Douglas W. Diamond, Yunzhi Hu () and Raghuram Rajan
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Douglas W. Diamond: Chicago Booth and NBER
Yunzhi Hu: University of North Carolina

IMF Economic Review, 2020, vol. 68, issue 1, No 2, 4-34

Abstract: Abstract Exchange rate appreciation in capital-receiving countries, induced by easy monetary policy in funding countries, increases the expected net worth of firms in receiving countries and their ability to buy assets. Anticipating this higher liquidity for their assets, corporations in capital-receiving countries lever up, and neglect alternative sources of debt capacity such as maintaining the pledgeability of their cash flows. When monetary policy in source countries tightens, receiving country exchange rates depreciate, and liquidity dries up in their corporate sector even if country prospects are sound. Since pledgeability has been neglected, debt capacity plummets, leading to a sudden stop in funding and subsequent financial distress. Exchange rate intervention by recipient countries to slow appreciation (and depreciation) may improve outcomes.

JEL-codes: E52 E58 F33 F34 G34 G38 O16 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1057/s41308-019-00095-z

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