February 2022

Devaluations, Deposit Dollarization, and Household Heterogeneity

Francesco Ferrante and Nils Gornemann

Abstract:

We study the aggregate and re-distributive effects of currency devaluations in a small open economy heterogeneous households model with leverage-constrained banks. Our framework captures three stylized facts about liability dollarization in emerging economies: i) banks and firms borrow in foreign currency; ii) households save in dollar-denominated local bank deposits; and iii) such deposits are mainly held by wealthier households. The resulting currency mismatch causes an erosion of banks' net worth during a devaluation, depressing credit supply. The ensuing macroeconomic downturn is amplified by a strong reduction of consumption among poorer households in response to rising borrowing costs and falling labor income. Richer households are partially insured, as they are holding a larger share of their wealth in foreign currency denominated assets. We show that a larger currency hedging by wealthier households deepens the recession and amplifies the negative spillovers for poorer agents. When deposit dollarization is high, welfare gains can arise if monetary policy dampens a depreciation.

DOI: https://doi.org/10.17016/IFDP.2022.1336

PDF: Full Paper

Disclaimer: The economic research that is linked from this page represents the views of the authors and does not indicate concurrence either by other members of the Board's staff or by the Board of Governors. The economic research and their conclusions are often preliminary and are circulated to stimulate discussion and critical comment. The Board values having a staff that conducts research on a wide range of economic topics and that explores a diverse array of perspectives on those topics. The resulting conversations in academia, the economic policy community, and the broader public are important to sharpening our collective thinking.

Back to Top
Last Update: February 16, 2022