Currency exposure and economic growth: Friend or foe?

Abstract

This study investigates the impact of currency mismatches on economic growth in advanced and developing economies. We introduce novel indices – broad original sin and new currency mismatch – constructed using a unique dataset on the currency composition of cross-border bank loans and international debt securities. These indices provide a comprehensive measure of currency exposure compared to previous studies. Our empirical findings reveal that currency mismatches significantly hinder economic growth, with depreciation further amplifying this adverse effect. Notably, exchange rate movements negatively impact growth through the financial channel, offsetting potential benefits through the trade channel. The empirical analysis suggests that countries with currency mismatches tend to perform better under fixed exchange rates. Importantly, this study shows that currency exposure is relevant for advanced economies as well, not just developing ones. To mitigate these negative effects, policymakers should consider limiting foreign currency-denominated debt issuance and promoting domestic bond market development.