Abstract
Facing acute strains in the offshore dollar funding markets during the COVID-19 crisis, the Federal Reserve (Fed) provided US dollar liquidity to the global economy by reactivating or enhancing swap arrangements with other central banks and establishing a new repo facility for financial institutions and monetary authorities (FIMA). This paper assesses motivations for the Fed liquidity lines, and the effects and spillovers of US dollar auctions by central banks using these lines. We find that the access to the Fed liquidity arrangements was driven by the recipient economies’ close financial and trade ties with the US. Access to dollar liquidity also reflected global trade exposure. We find that announcements of expansion of Fed liquidity facilities or of auctions using these facilities led to appreciation of partner currencies against the US dollar and reduced these currencies’ deviations from covered interest parity (CIP). Dollar auctions by major central banks (BoE, ECB, BoJ and SNB) had spillovers: they led to temporary appreciation of other currencies against the US dollar, reduced CIP deviations, and persistently reduced sovereign bond yields of other economies. However, dollar auctions done by non-major central banks with access to Fed facilities did not have a meaningful impact on key domestic financial variables. The impact of major central bank auctions does not differ by the economies’ financial or trade links with the US or their balance sheet currency exposure, i.e. the major central bank auctions benefitted even the more vulnerable economies.
Highlights
The COVID-19 crisis saw an emergence of acute strains in the offshore dollar funding markets in March 2020
On the determinants of the size of access to liquidity arrangements, we find that an economy with high levels of US bank exposure and stronger trade ties with the US tended to have greater access to Federal Reserve (Fed) liquidity, via swap lines or foreign and international monetary authorities (FIMA)
The economic impacts of Federal Reserve liquidity lines we investigate the impact of Fed liquidity facilities on four financial variables, namely, the exchange rate against the US dollar, 10-year government bond yields, credit default swap (CDS) spreads and the absolute cross currency basis, while controlling for an exhaustive list of other domestic and international economic conditions and policies
Summary
The COVID-19 crisis saw an emergence of acute strains in the offshore dollar funding markets in March 2020. Dollar auctions by smaller central banks with Fed facilities did not have significant domestic effects, but dollar auctions by major central banks (BoE, ECB, BoJ and SNB) led to short-term appreciation of other, non-major currencies against the US dollar, reduced the size of the cross-currency basis and persistently reduced long-term government bond yields These results do not change by these economies’ financial or trade exposure to the US. The results of our paper are in line with Gourinchas and Rey (2007), Obstfeld et al (2009), and Gopinath et al (2020), analyzing the “exorbitant privilege” position of the US dollar, and the dominant currency paradigm These considerations suggest that the Fed’s swap lines and emergency liquidity provisions of the FIMA type may impact most emerging and developing economies, including nations with limited trade and financial dealings with the US.
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