Dollar borrowing in emerging markets

This dissertation analyzes the reasons, the macroeconomic consequences, and the social efficiency of the use of dollar-denominated debt by emerging market agents in their borrowing relationships with international lenders.; We begin with a brief introduction that features a discussion of the destabilizing role of dollar debt in financial crises and of exisiting explanations for why private borrowers nonetheless expose themselves to these risks.; Chapter 2 shows in a simple, generic model that the standard assumptions that are traditionally used in the open economy macroeconomics literature to describe borrowing decisions, in particular risk-neutral international capital markets, imply - counterfactually - that private agents always use the maximum amount of local currency debt possible to insure themselves against aggregate shocks and never take on any dollar debt. In fact, in perfect capital markets this leads to full insurance against aggregate shocks in the economy.; Chapter 3 develops a new macroeconomic framework that captures what we argue is the central factor why emerging market borrowers expose themselves to the risks of dollar debt: that local currency debt is more expensive because international investors charge a risk premium on it. Using this framework, we show that dollar debt raises the volatility of macroeconomic variables such as domestic consumption, the current account, and exchange rates.; In chapter 4, we show that in the presence of financial constraints, rational private firms take on excessive dollar debts because they fail to internalize that more dollar debt implies stronger depreciations of the exchange rate in crisis states, which by extension depreciates the value of their collateral; this makes borrowing constraints tighter and increases the incidence and severity of financial crises.; Chapter 5 evaluates a number of policy options that can be employed to discourage emerging market firms from excessive dollar borrowing. We find that an unremunerated reserve requirements on dollar debt is the best instrument to implement the social optimum in an environment in which risk premia in the market fluctuate. Furthermore, we argue that local currency-denominated bonds are a superior risk-sharing instrument to GDP-linked bonds.