The granular origins of exchange-rate fluctuations

Simon Lloyd, Daniel Ostry and Balduin Bippus

How much capital flows move exchange rates is a central question in international macroeconomics. A major challenge to addressing it has been the difficulty identifying exogenous cross-border flows, since flows and exchange rates can evolve simultaneously with factors like risk sentiment. In this post, we summarise a staff working paper that resolves this impasse using bank-level data capturing the external positions of UK-based global intermediaries to construct novel ‘Granular Instrumental Variables‘ (GIVs). Using these GIVs, we find that banks’ United States dollar (USD) demand is inelastic – a 1% increase in net-dollar assets appreciates the dollar by 2% against sterling – state dependent – effects double when banks’ capital ratios are one standard deviation below average – and that banks are a ‘marginal investor’ in the dollar-sterling market.

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