Equilibrium Foreign Currency Mortgages
Electronic Access:
Free Download. Use the free Adobe Acrobat Reader to view this PDF file
Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
Summary:
This paper proposes a novel explanation for why foreign currency denominated loans to households have become so popular in some emerging economies. Our argument is based on what we call the debt limit channel, which arises when multi-period contracts are offered to financially constrained borrowers against collateral that is established on newly acquired assets. Whenever the difference between domestic and foreign interest rates is positive, this effect biases borrowers’ choices towards foreign currency, even if the exchange rate is known to depreciate as implied by the interest parity condition. We demonstrate in a structural macroeconomic framework that the debt limit channel is quantitatively important and can result in dollarization of debt also in the presence of realistic exchange rate risk. Comparing this outcome to allocations under constrained-optimal time-consistent policy reveals that a substantial part of the identified bias towards foreign currency is due to a pecuniary externality, i.e. borrowers’ failure to internalize how their currency choice affects collateral prices.
Series:
Working Paper No. 2021/084
Subject:
Asset and liability management Currencies Debt limits Economic sectors Financial crises Financial institutions Housing Loans Money Mortgages National accounts
Frequency:
regular
English
Publication Date:
March 19, 2021
ISBN/ISSN:
9781513574394/1018-5941
Stock No:
WPIEA2021084
Format:
Paper
Pages:
42
Please address any questions about this title to publications@imf.org