Cross-country spillover effects of interest rate and credit constraint policies

Both rising interest rates and tighter credit constraints decrease investors’ funding positions in a given currency and cause the currency to appreciate. I extend the Gabaix and Maggiori (2015) global multi-country currency and bond model and show that the policy interventions have opposite effects on the value of an alternative funding currency through investor positioning. Rising interest rates encourage investors to shift their positioning and cause the alternative currency to depreciate. Tightening credit conditions have the contrasting effect and prompt appreciation for both currencies. Empirical evidence on Japanese Yen returns is consistent with the model.