Transmission of monetary policy and exchange rate shocks under foreign currency lending

This paper analyses the differences in reaction of domestic and foreign currencylending to monetary and exchange rate shocks, using a panel VAR model estimatedfor three biggest Central and Eastern European countries (Poland, the CzechRepublic and Hungary). Our results point toward a drop in domestic currency loansand an increase of foreign currency credit in reaction to monetary policy tighteningin Poland and Hungary, suggesting that the presence of foreign currency debtweakens the transmission of monetary policy. A currency depreciation shock leadsto an initial decline in foreign currency lending, but also in loans denominated indomestic currency as central banks react to a weaker exchange rate by increasingthe interest rates. However, after several quarters, credit in foreign currencyaccelerates, indicating that borrowers start using it to substitute for depresseddomestic currency lending.