DF Lunch Seminar: Prof. Paul Fontanier on Financial Intermediation and Liquidity

“Exchange Rate Stabilization and Monetary Transmission ”

With the Lunch Seminar series, the Department of Finance is bringing eminent and up-and-coming researchers from around the world to Luxembourg.

Abstract

This paper challenges the conventional Mundellian trilemma by arguing that exchange rate stabilization can enhance rather than constrain monetary policy effectiveness in emerging markets. We develop a theoretical model with segmented financial markets where domestic arbitrageurs face risk limits. We show that exchange rate stability attracts foreign investment in local-currency bonds, relaxing financial frictions on domestic arbitrageurs. This strengthens policy rate transmission to long-term yields, giving the central bank better control over the output gap. Our framework shows that it is always optimal to introduce some level of exchange rate targeting. Excessive stabilization such as a hard currency peg, however, raises policy rate volatility, offsetting these gains by increasing the amount of duration risk that must be borne by local arbitrageurs.

About the speaker

Paul Fontanier is an Assistant Professor in the Finance group at Yale SOM . He is an applied theorist with interests at the intersection of Finance and Macroeconomics. His research focuses on financial stability, with an emphasis on monetary policy and financial regulation.

He received a PhD from Harvard University in 2022 and is a graduate of Ecole Polytechnique and Corps des Mines.