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The Dollar Exchange Rate as a Global Risk Factor: Evidence from Investment
IMF Economic Review  (IF2.761),  Pub Date : 2019-02-05, DOI: 10.1057/s41308-019-00074-4
Stefan Avdjiev, Valentina Bruno, Catherine Koch, Hyun Song Shin

Exchange rate fluctuations could influence economic activity not only via the standard trade channel, but also through a financial channel, which operates through the impact of exchange rate fluctuations on borrowers’ balance sheets and lenders’ risk-taking capacity. This paper explores the “triangular” relationship between (1) the strength of the US dollar, (2) cross-border bank flows and (3) real investment. We conduct two sets of empirical exercises—a macro (country-level) study and a micro (firm-level) study. We find that a stronger dollar is associated with lower growth in dollar-denominated cross-border bank flows and lower real investment in emerging market economies. An important policy implication of our findings is that a stronger US dollar has real macroeconomic effects that go in the opposite direction to the standard trade channel.