International financial intermediation and currency mismatches: Original sin and conflicted virtue

It has long been recognized that the health of the financial industry plays a key part in macroeconomic fluctuations. This dissertation studies the role of the financial sector in intermediating cross-border capital flows which offset the current account and the relationship of that role to macroeconomic performance.; Chapter 1 motivates the study of currency mismatch in the financial sector by comparing the role played by the banking collapse of the 1930s during the Great Depression to that of the banking problems faced by Japan during its extended macroeconomic slump of the 1990s. In particular, I conclude that the Japanese problem fundamentally differs from the Depression in that the inability of the financial sector to effectively finance the current account plays an integral part in the persistence of the slump. By contrast, during the Depression, the link between the banking collapse and the macroeconomic slump could be explained primarily through the impact of the former on the money supply and domestic credit intermediation.; Chapter 2 develops a model of financial intermediation incorporating currency mismatch between assets and liabilities resulting from original sin (in the case of a debtor economy) or conflicted virtue (in the case of a creditor). We see that the ability of the financial sector to effectively finance the current account is reduced by a negative shock to equity or an increase in exchange rate volatility. The intermediary model is able to generate a more meaningful currency risk premium than the benchmark representative agent models.; Chapter 3 examines the dynamics of the currency mismatch problem in East Asia as the region has gone from running sizable and persistent current account deficits financed by private dollar borrowing during the pre-crisis era, to running substantial current account surpluses which the central banks frequently have been forced to finance in the years since the crisis. I argue that the IMF advice to float the exchange rate is misplaced in light of the fact that the current account has reversed and that the financial sector is discouraged from accumulating a sizable net foreign asset position due to increased exchange rate volatility.