Discussion Paper Details

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Title: Household Heterogeneity and the Transmission of Foreign Shocks

Author(s): Sergio de Ferra, Kurt Mitman and Federica Romei

Publication Date: October 2019

Keyword(s): Exchange Rate Policy, foreign currency debt, incomplete markets and Sudden stops

Programme Area(s): International Macroeconomics and Finance and Monetary Economics and Fluctuations

Abstract: We study the role of heterogeneity in the transmission of foreign shocks. We build a Heterogeneous-Agent New-Keynesian Small Open Model Economy (HANKSOME) that experiences a current account reversal. Households' portfolio composition and the extent of foreign currency borrowing are key determinants of the magnitude of the contraction in consumption associated with a sudden stop in capital inflows. The contraction is more severe when households are leveraged and owe debt in foreign currency. In this setting, the revaluation of foreign debt causes a larger contraction in aggregate consumption when debt and leverage are concentrated among poorer households. Closing the output gap via an exchange-rate devaluation may therefore be detrimental to household welfare due to the heterogeneous impact of the foreign debt revaluation. Our HANKSOME framework can rationalize the observed "fear of floating" in emerging market economies, even in the absence of contractionary devaluations.

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Bibliographic Reference

de Ferra, S, Mitman, K and Romei, F. 2019. 'Household Heterogeneity and the Transmission of Foreign Shocks'. London, Centre for Economic Policy Research.