Global Banks, Global financial cycles and Exchange rate policies

Since 1990s, the international claims of global banks have grown ten-fold. Financial conditions now transmit across borders. Global banks obtain liquidity from the US and import global liquidity conditions to economies without control of capital flows. For these economies, the domestic interest rate policy may no longer be an adequate tool to control local credit conditions and business cycles, regardless of the domestic exchange rate regime.

To analyze these phenomena, I propose to build a two-country dynamic stochastic general equilibrium (DSGE) model with a global banking sector and asymmetric monetary policies in the US and the rest of the world.

The model will be calibrated with US and Europe data and simulations will be performed. The model will allow us to study the following questions: (a) Do global banks make business cycles and credit cycles more synchronised when the US is hit by real shocks, financial shocks and uncertainty shocks? (b) Do we expect more comovements in the external finance premium, bank leverages and cross-border capital flows? (c) Does choosing a flexible exchange rate regime, as standard Mundell-Fleming model suggests (Mundell, 1962; Fleming, 1962), better insulate an economy from the global credit cycle? (d) Can capital controls be desirable?

This project provides key theoretical underpinnings to the “dilemma-versus-trilemma” debate in international macroeconomics. It is likely to yield practical implications to the conduct of monetary policy and exchange rate policy in the financially-integrated world nowadays.