Volha Audzei, Jan Brůha, Ivan Sutóris
In this paper, we study domestic and foreign monetary policy transmission in a small open economy in which firms can decide to hold foreign currency loans (FCLs). In a workhorse two-country DSGE model, firms borrow in advance to cover production costs and choose the share of FCLs based on interest rate differentials and expected exchange rate movements. In this framework, we further examine how FCL holdings affect the transmission of exogenous shocks and monetary policy. The results indicate that FCLs impact the effectiveness of domestic policy depending on the shock type: they strengthen monetary policy transmission in response to domestic shocks, while weakening it in response to asymmetric foreign and exchange rate shocks. Symmetric global supply shocks reduce domestic policy efficacy, requiring higher rates to curb inflation but causing larger output losses. In contrast, global demand shocks allow for less aggressive domestic policy responses under large FCL holdings.
JEL codes: E32, E44, E52, F41
Keywords: Cost channel of monetary policy, dynamic stochastic general equilibrium models, foreign currency loans, small open economy
Issued: June 2025
Download: CNB WP No. 10/2025 (pdf, 794 kB)