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CEP discussion paper
Monetary Policy Rules and Foreign Currency Positions
Bianca De Paoli, Hande Küçük-Tuger and Jens Søndergaard
November 2010
Paper No' CEPDP1022:
Full Paper (pdf)

JEL Classification: F31; F41

Tags: portfolio choice; international transmission of shocks; monetary policy

Using an endogenous portfolio choice model, this paper examines how different monetary policy regimes can lead to different foreign currency positions by changing the cyclical properties of the nominal exchange rate. We find that strict inflation targeting regimes are associated with a short position in foreign currency, while the opposite is true for noninflation targeting regimes. We also explore how these different external positions affect the international transmission of monetary shocks through the valuation channel. When central banks follow inflation targeting Taylor-type rules, valuation effects of monetary expansions are beggar-thy-self, but they are beggar-thy-neighbour in a money growth targeting regime (or when monetary policy puts weight on output stabilization).