Household Heterogeneity and the Transmission of Foreign Shocks

This paper builds a Heterogeneous-Agent New-Keynesian Small Open Model Economy (HANKSOME) – combining the standard Bewley-Imrohoroğlu-Huggett-Aiyagari incomplete-markets household block with the Galí and Monacelli (2005) small-open-economy New Keynesian framework – to study how household heterogeneity shapes the transmission of a foreign credit-supply shock, motivated by Hungary’s foreign-currency mortgage boom of the 2000s and its sudden-stop reversal around 2009. Its central finding is that when households owe debt denominated in foreign currency, a floating exchange rate’s depreciation mechanically revalues that debt upward, reducing net worth and triggering a sharp contraction in consumption that is concentrated among highly leveraged, high-marginal-propensity-to-consume, low-wealth households – even though aggregate output actually rises on impact via a labor-supply response, so the usual “contractionary devaluation” mechanism is not what drives the welfare loss. As a result, a fixed exchange rate, despite generating its own recession through binding nominal rigidities, prevents most of this debt revaluation and is preferred by more than 90% of households in the paper’s Hungary-calibrated experiment, providing a welfare-based rationale for the empirically documented “fear of floating” that does not rely on devaluations being output-contractionary.

Sergio De Ferra | Macro Paper Warehouse

Household Heterogeneity and the Transmission of Foreign Shocks