Equilibrium foreign currency mortgages

This paper proposes a novel explanation for why foreign currency denominated loans to households have become so popular in some emerging economies. Our argument is based on what we call the debt limit channel, which arises when multi-period contracts are offered against collateral that established newly acquired assets. Whenever difference between domestic and interest rates positive, this effect allows financially constrained agents backload real payments their if they choose borrow currency. We demonstrate structural macroeconomic framework channel quantitatively important can result dollarization of despite realistic correctly perceived exchange rate risk. Comparing outcome allocations under constrained-optimal policy reveals much identified bias towards due pecuniary externality, i.e. borrowers' failure internalize how choice affects house prices.