Central Banks as Dollar Lenders of Last Resort: Implications for Regulation and Reserve Holdings

We explore how foreign central banks behave when firms engage in currency mismatch, borrowing heavily in dollars. A central bank can deal with risky private-sector mismatch in two ways: (i) with financial regulation or (ii) by accumulating reserves to better serve as a dollar lender of last resort. We highlight a novel externality: Individual central banks may overaccumulate dollar reserves, as this exacerbates a global scarcity of dollar-denominated assets, lowering dollar interest rates and encouraging firms to further increase their currency mismatch. Relative to the decentralized outcome, a global planner may prefer tighter financial regulation and reduced holdings of dollar reserves. (JEL E43, E44, E58, F31, F41, G21, G28)