The Missing Channel: Why Liability Dollarization Could Overturn the Emerging-Market Results in Drechsel, McLeay, Tenreyro and Turri (2026)

A critical review of Drechsel, McLeay, Tenreyro and Turri (2026), “How should central banks respond to commodity price shocks? Optimal monetary and exchange rate frameworks for commodity-exposed economies.” Working paper, London School of Economics, 15 April 2026.

1. Introduction

How should monetary policy respond to commodity-price shocks in small open economies, and how should the choice of exchange-rate framework depend on whether a country imports or exports those commodities? This question, central to open-economy macroeconomics since Aoki (2001) and Galí and Monacelli (2005), had reached something resembling a consensus before 2022: stabilise domestic (sticky-price) inflation, let flexibly-priced commodity components adjust, and “look through” the direct effects of commodity shocks on the headline CPI. The energy-price episodes of 2022–2024 reopened the question, particularly with respect to the indirect transmission of energy costs through firms’ marginal costs.

Drechsel, McLeay, Tenreyro and Turri (2026) — hereafter DMTT — offer a remarkably ambitious answer. They build a tractable New Keynesian small open economy model that can be recalibrated to represent four distinct economy types (advanced/emerging × commodity-importer/exporter), incorporate flexible-price commodity exports priced in dollars, and — crucially — allow the country risk premium to depend endogenously on commodity prices, building on Drechsel and Tenreyro (2018). The paper compares the welfare performance of four policy regimes: a benchmark Ramsey-optimal commitment plan; strict domestic-inflation targeting (DIT); strict CPI targeting; and a nominal exchange-rate peg.

This review is structured as follows. Section 2 reconstructs the model. Section 3 summarises the five central results. Section 4 identifies what is genuinely new and valuable in the contribution. Section 5 — the core of this review — argues that the paper’s omission of liability dollarization is more consequential than the authors acknowledge, and that incorporating this channel could plausibly overturn at least one of the emerging-market conclusions. Section 6 discusses implications for the policy taxonomy. Section 7 concludes.

2. What the paper does

DMTT extend the canonical Galí–Monacelli (2005) small open economy framework along four dimensions. First, they introduce three distinct roles for commodities: as export goods, as imported consumption goods, and as imported intermediate inputs in domestic production. This generalises the authors’ earlier work on commodity-exporting economies, allowing the same model to speak to both energy importers and resource exporters.

Second, they adopt a mixed-currency pricing structure: monopolistic differentiated exports are priced in producer currency (sticky in domestic currency), while competitive commodity exports are flexibly priced in dollars. This is methodologically important because it preserves the allocative role of the exchange rate — exchange-rate movements still affect relative commodity supply decisions — in contrast to the dominant-currency pricing model of Gopinath, Boz, Casas, Díez, Gourinchas and Plagborg-Møller (2020), in which exchange rates have substantially muted real effects.

Third, they incorporate imperfect international risk sharing through an endogenous country risk premium that depends on (i) the level of external debt, following Schmitt-Grohé and Uribe (2003), and (ii) global commodity prices — decreasing in the export-commodity price and increasing in the import-commodity price. The empirical motivation rests on the evidence in Drechsel and Tenreyro (2018) and the broader literature on terms-of-trade shocks in emerging economies. Calibration values are taken from the literature: for emerging markets, the semi-elasticity of the risk premium to export-commodity prices is set to 0.2, following Drechsel and Tenreyro (2018); for advanced economies it is scaled down by a factor of 1,000.

Fourth, they derive optimal commitment policy using the linear-quadratic methodology of Benigno and Woodford (2012), and compare welfare losses against three simple rules: DIT, CPI targeting, and an exchange-rate peg. The main quantitative analysis focuses on Cole–Obstfeld preferences, following Cole and Obstfeld (1991) (unitary substitution elasticities), with extensions to η = 0.2 and η = 4 in Section 6 of the paper.

The model is parsimonious enough that the same equations describe an advanced commodity exporter (e.g. Australia, Norway, Canada), an emerging commodity exporter (Argentina, Chile, Ghana), an advanced commodity importer (Germany, Italy, Japan), and an emerging commodity importer (India, Vietnam, Turkey). Only a few parameters vary across cases: the risk-premium elasticities, the share of monopolistic versus commodity exports, and the import-commodity shares in consumption and intermediates.

3. The five central results

DMTT’s findings can be condensed into five propositions.

(i) Commodity exporters. Under a positive commodity export price shock, strict domestic inflation targeting is approximately welfare-optimal, while exchange-rate pegs deliver substantially worse outcomes. The intuition rests on the flexible pricing of commodity exports: the shock creates no relative-price distortion in the sticky-price sector, and stable domestic prices simultaneously stabilise wages and close the efficient output gap. A peg, by preventing the optimal nominal appreciation, generates an inefficient boom in employment and consumption.

(ii) Commodity importers. For an energy-price shock to a commodity importer, the ranking reverses: strict DIT performs significantly worse than either CPI targeting or an exchange-rate peg. This is the most striking result of the paper. Because energy enters production as an intermediate input, sticky-price firms face a rise in marginal costs that DIT can only neutralise through wage deflation and a large negative output gap. The optimal policy instead “looks through” not only the direct effect of energy on the CPI (the conventional heuristic) but also the indirect effect via firms’ costs — an extension of the looking-through doctrine that, as the authors emphasise, contrasts with much current central-bank practice.

(iii) Emerging-market amplification through endogenous risk premia. When the risk premium co-moves procyclically with commodity prices, the trade-offs facing emerging economies become substantially starker. For exporters, the rise in commodity prices relaxes the financial constraint and requires a much larger real appreciation — roughly 10% nominal appreciation against a CPI inflation fall of nearly 15% annualised. For importers, a sharp rise in the risk premium following an adverse shock makes strict stabilisation of domestic inflation implausible: it would require an extreme contraction in employment. The authors argue that this procyclicality of credit conditions provides a structural rationale for the “fear of floating” documented by Calvo and Reinhart (2002).

(iv) Correlated shocks. When import and export commodity prices move together — as they typically do in practice — the optimal policy lies between strict DIT and the peg, and no simple rule is robustly optimal.

(v) Wage inflation targeting. Across all model variants and calibrations, the optimal policy is consistent with stable wage inflation. The authors interpret this as theoretical support for the common central-bank practice of responding strongly to “second-round effects” while looking through direct commodity impacts.

4. What is genuinely new

The paper makes three contributions that warrant emphasis.

First, the unification under a single tractable framework of four economy types previously studied separately — advanced commodity exporters (Drechsel and Tenreyro, 2018; Fernández, Schmitt-Grohé and Uribe, 2018), advanced commodity importers (Bodenstein, Erceg and Guerrieri, 2008, 2011), and their emerging-market counterparts — is methodologically valuable. The model is genuinely flexible: the four cases differ only in a small set of parameters, which discourages the temptation to attribute results to functional-form choices specific to one country class.

Second, the extension of the “looking through” doctrine to indirect effects — result (ii) — is a real conceptual advance. The pre-2022 consensus, articulated since Aoki (2001), was about looking through direct CPI effects of flexibly priced sectors. DMTT’s contribution is to show that even when energy enters as an intermediate input in sticky-price production — generating persistent core-inflation effects — the optimal response is not to lean against those effects. This is a theoretically grounded refinement of practitioner heuristics that have so far rested on informal arguments about transmission lags.

Third, the formalisation of endogenous risk premia as a structural source of asymmetry between advanced and emerging economies — result (iii) — is the paper’s most genuinely original technical contribution. The mechanism is parsimonious: with procyclical financial conditions, the Ramsey planner cannot offset the exogenous component of the risk-premium movement, and consumption must absorb a larger share of the adjustment than in advanced economies. This rationalises the empirical observation, first systematised by Aguiar and Gopinath (2007), that emerging-market consumption is significantly more volatile than output, without invoking trend shocks.

5. The missing channel: liability dollarization

The most consequential limitation of the paper is the explicit omission of liability dollarization. The authors are aware of this. In footnote 7 they note that “our model abstracts from a dollarised-liability channel, as emphasized for example by Cook (2004),” and in footnote 15 they elaborate: “Introducing such a channel could potentially imply a stronger benefit of lower exchange rate volatility, especially in emerging economies.” This is a substantial admission. In what follows, I argue that the omission is more consequential than these footnotes acknowledge, and that incorporating it could plausibly reverse at least one of the paper’s core emerging-market results.

5.1 The two financial frictions are not substitutes

DMTT model one financial friction — a risk premium on external debt that varies endogenously with commodity prices and the level of debt — and explicitly omit a second: balance-sheet effects arising from foreign-currency-denominated liabilities held by domestic agents. These two channels are conceptually distinct and operate through different transmission mechanisms.

The risk premium channel, as formalised by Schmitt-Grohé and Uribe (2003) and extended by Drechsel and Tenreyro (2018), is an aggregate, external-debt phenomenon: it affects the price at which the country borrows abroad. The liability-dollarization channel, first formalised in the “third-generation” crisis literature by Krugman (1999) and developed by Aghion, Bacchetta and Banerjee (2001), Céspedes, Chang and Velasco (2004), and Cook (2004), is a microeconomic balance-sheet phenomenon: when domestic firms or households hold foreign-currency liabilities against domestic-currency assets, a real depreciation directly transfers wealth away from leveraged agents, contracts net worth, tightens collateral constraints, and reduces investment and consumption. The two frictions can — and in emerging markets typically do — operate simultaneously.

This distinction matters because the two channels have different policy implications. The endogenous risk premium amplifies the benefits of optimal stabilisation but does not fundamentally alter the sign of the optimal exchange-rate response. The balance-sheet channel, by contrast, can reverse that sign: depreciations that would be expansionary in a Mundell–Fleming world become contractionary when they destroy domestic net worth, as Cook (2004) shows explicitly in a calibrated New Keynesian model. The key result in Cook (2004, p. 1155) is that, once liability dollarization is incorporated with empirically plausible magnitudes, “the stabilization properties of a fixed exchange rate regime are superior to a set of interest rate rules that target inflation.” This conclusion stands in direct tension with DMTT’s first result for emerging-market commodity exporters.

5.2 Mechanics of the balance-sheet channel

The canonical formulation runs as follows. Domestic entrepreneurs finance capital with a combination of domestic-currency equity and foreign-currency debt. Their net worth at date t equals the return on their projects minus the domestic-currency value of their outstanding foreign-currency liabilities. Under a binding collateral constraint à la Bernanke, Gertler and Gilchrist (1999), investment is bounded above by a multiple of net worth. A real depreciation simultaneously raises the return on tradable production (Mundell–Fleming channel) and raises the domestic-currency value of foreign-currency debt (balance-sheet channel). When the share of foreign-currency liabilities is large, the second effect can dominate.

Céspedes, Chang and Velasco (2004), in the AER paper that consolidates this literature, derive analytical conditions under which the balance-sheet effect overturns the conventional Mundell–Fleming result. They show that, with sticky wages, endogenous country risk premia, and dollarised liabilities, “the impact of an adverse foreign shock can be strongly magnified by the balance sheet effect of the associated real devaluation.” Critically, all three of these ingredients are already present in DMTT’s framework — except the dollarised liability itself.

A more recent and arguably more relevant reference is Bocola and Lorenzoni (2020). In an American Economic Review paper, they endogenise liability dollarization as an equilibrium outcome of an insurance motive: because financial crises in emerging economies coincide with depreciations, savers demand a premium to hold domestic-currency assets, which makes domestic-currency debt expensive and incentivises foreign-currency borrowing. The mechanism produces multiple equilibria, with the “bad equilibrium” featuring high dollarization and elevated financial fragility. This matters for DMTT’s framework because it suggests that liability dollarization is not a residual artefact of underdeveloped financial markets that can be assumed away in modern calibrations — it is a structural equilibrium feature of economies with the very risk-premium properties that DMTT model.

5.3 Where the channel could reverse DMTT’s emerging-market exporter result

Consider DMTT’s result (i) applied to an emerging-market commodity exporter facing a negative commodity-price shock — the case symmetric to the positive shock they simulate. In their model, the optimal response is a sharp real depreciation, achieved through DIT and a free float. The intuition is that DIT closes the output gap by allowing the exchange rate to absorb the shock, while a peg would force an inefficient contraction in employment.

Now introduce liability dollarization. The optimal depreciation under DIT now triggers a wealth transfer away from the leveraged domestic non-financial corporate sector, contracts net worth, tightens collateral constraints, and reduces investment. This second-order effect can be quantitatively large: in the calibration of Céspedes, Chang and Velasco (2004), and in the structural estimation of Cook (2004) for East Asian economies, balance-sheet effects can fully offset — and sometimes reverse — the conventional expansionary effect of depreciation on tradable production. Empirical evidence for Turkey by Kesriyeli, Özmen and Yiğit (2011) and for Latin American economies in the dataset compiled by Lane and Shambaugh (2010) confirms that the channel remains quantitatively relevant.

Under such conditions, the welfare ranking between DIT and the peg for emerging-market exporters is no longer obvious. The peg avoids the destructive balance-sheet effect of the depreciation, at the cost of forgoing the efficient relative-price adjustment in the export sector. Which effect dominates is a quantitative question that DMTT’s model, by construction, cannot answer.

This is the precise sense in which the omission is consequential. DMTT’s framework rules out one of the two financial frictions that emerging-market policy practitioners and the third-generation crisis literature have identified as central to the choice of exchange-rate regime. The “fear of floating” they explain through procyclical risk premia is, in the historical record, almost always co-determined with the fear of balance-sheet destruction — a point made explicitly in the survey by Calvo and Mishkin (2003).

5.4 Has the channel disappeared?

DMTT cite Du and Schreger (2022) and Engel and Park (2022) to motivate the assumption that dollarisation is becoming less relevant. Both papers document an important trend: the share of emerging-market sovereign external debt issued in local currency has risen substantially since the early 2000s. This is real and matters for sovereign-default risk.

But the relevant channel for the balance-sheet effect in macroeconomic stabilisation is not sovereign liability dollarization — it is corporate and household liability dollarization. Here the picture is considerably less clean. The work of Hofmann, Patel and Wu (2022) on the “original sin redux” hypothesis is precisely on point: the shift from foreign-currency to local-currency external borrowing does not eliminate emerging-market vulnerability to foreign financial shocks, because currency mismatches re-emerge in private-sector balance sheets and in the balance sheets of foreign lenders that hold local-currency claims. Hofmann, Shim and Shin (2020) document that even in countries with reduced sovereign dollarization, the financial channel of the exchange rate continues to operate through corporate balance sheets.

This is directly relevant to DMTT’s calibration choices. Among the emerging-market exporter cases they cite as exemplars — Argentina, Chile and Ghana — at least two (Argentina and Chile) feature corporate-sector currency mismatches that are well documented and quantitatively non-trivial (Galiani, Levy Yeyati and Schargrodsky, 2003; Cowan, Hansen and Herrera, 2005; Drenik, Kirpalani and Perez, 2022). A calibration exercise that purports to evaluate optimal exchange-rate frameworks for these economies cannot, in good faith, abstract from this feature.

5.5 What a corrected framework might look like

I do not claim that incorporating liability dollarization would overturn all of DMTT’s results. The advanced-economy results are likely unaffected, as is the optimal “looking through” prescription for energy importers — the balance-sheet channel operates through the exchange rate, not through the energy price per se. The wage-inflation targeting result (v) might prove quite robust, since wage stabilisation does not require exchange-rate volatility. The result most likely to be revised is (i) for emerging-market exporters, and the magnitude of (iii) more generally. What follows is an attempt to specify, with some precision, what an extended framework would require and what new predictions it would deliver.

5.5.1 Minimal modifications to the DMTT structure

The DMTT framework can accommodate liability dollarization with a relatively contained set of modifications, building on the integration strategy of Céspedes, Chang and Velasco (2004) and Gertler, Gilchrist and Natalucci (2007). Three changes are required.

First, the model needs a leveraged domestic agent — either an entrepreneurial sector financing capital accumulation, as in Bernanke, Gertler and Gilchrist (1999), or a banking sector intermediating between savers and firms, as in Gertler and Karadi (2011). The DMTT representative household, which holds external bonds directly, cannot generate a balance-sheet channel because it has no leverage and no collateral constraint. The simplest extension — adopted by Cook (2004) — introduces entrepreneurs with finite net worth who borrow internationally to fund capital, and whose investment is constrained by net worth through an external finance premium.

Second, a fraction ω of the entrepreneurial sector’s external liabilities must be denominated in foreign currency. The entrepreneur’s net worth at the end of period t then evolves as

Nt+1 = (1 − γ)[RKt+1 · Qt · Kt+1 − Et+1 · (ω · Bt) − (1 − ω) · Bt]

where RK is the return on capital, Qt · Kt+1 is the value of the capital stock, Bt is total debt, Et+1 is the nominal exchange rate, and γ is the entrepreneur’s exit rate. A real depreciation (ΔEt+1 > 0) directly reduces net worth proportionally to ω, tightening the external finance premium and reducing investment.

Third, the international borrowing premium that DMTT model as depending on commodity prices, Φ(Bt, Pc,t∗, Pc̃,t−1∗), must be augmented to depend also on entrepreneurial net worth: Φ(Bt, Pc,t∗, Pc̃,t−1∗, Nt), with ∂Φ/∂Nt < 0. This is the BGG external finance premium, integrated with the DMTT specification. Critically, this preserves the DMTT mechanism (commodity prices still affect the risk premium directly) while adding the balance-sheet amplification (depreciations affect the risk premium indirectly through net worth).

5.5.2 Calibration of the new parameter

The new structural parameter is ω, the share of foreign-currency liabilities in the entrepreneurial sector. For commodity-exporting emerging economies, empirical estimates fall within a relatively well-defined range. For Argentina, Galiani, Levy Yeyati and Schargrodsky (2003) document substantial corporate dollar-debt shares in the tradable sector during the currency-board period, and Drenik, Kirpalani and Perez (2022) provide more recent evidence on the persistence of foreign-currency contracting in private agreements. For Chile, Cowan, Hansen and Herrera (2005) document corporate dollar liabilities of approximately 25–40% in the non-financial corporate sector, with substantial heterogeneity across firms and significant balance-sheet effects following depreciations once the analysis properly controls for the currency composition of revenues, assets and derivatives.

A conservative calibration would set ω = 0.3 for the emerging-market exporter case, with sensitivity analysis over the range ω = 0.1 to 0.5. This is consistent with the calibration in Gertler, Gilchrist and Natalucci (2007), who use a foreign-currency liability share of 0.4 for their Korean economy benchmark. For advanced economies, ω should be set close to zero, reflecting the empirical near-absence of corporate currency mismatches in Australia, Canada or Norway.

The remaining BGG parameters — the entrepreneurial exit rate γ, the monitoring cost μ in the costly-state-verification problem, and the elasticity of the external finance premium with respect to leverage — can be taken directly from Bernanke, Gertler and Gilchrist (1999) and the subsequent literature. These parameters affect the quantitative magnitude of the balance-sheet effect but not its sign.

5.5.3 Three testable predictions that differentiate the extended framework

The extended framework yields predictions that depart from DMTT in ways that are, at least in principle, empirically distinguishable.

Prediction 1 (sign reversal at high dollarization). There exists a threshold ω̄ such that, for ω > ω̄, the welfare ranking of policy regimes for an emerging-market commodity exporter facing an adverse commodity-price shock flips: the exchange-rate peg dominates strict DIT in welfare terms. This contrasts with DMTT’s Table 5, which finds DIT dominant by a large margin (welfare loss of 14.75 percentage points under the peg versus 0 under DIT). Cook (2004) finds analogous threshold behaviour in his calibrated model: the peg dominates inflation-targeting rules once liability dollarization exceeds roughly 40% of corporate liabilities, consistent with the BGG-based mechanics.

Prediction 2 (asymmetric response to shocks of opposite sign). Because the balance-sheet channel is most powerful following depreciations (not appreciations), the welfare cost of DIT relative to a peg should be substantially larger for adverse commodity shocks than for favourable ones of equal magnitude. DMTT’s framework, which treats the optimal exchange-rate response as locally symmetric around the steady state, cannot generate this asymmetry. The empirical literature on sudden stops (Calvo, Izquierdo and Talvi, 2006; Mendoza, 2010) documents precisely this asymmetric response pattern in emerging-market data, providing indirect support for the extended framework.

Prediction 3 (interaction with reserve accumulation). In the extended framework, the optimal policy combines exchange-rate management with reserve accumulation, since reserves can be deployed ex post to dampen the depreciation and protect entrepreneurial net worth. This is the central insight of Bocola and Lorenzoni (2020): foreign reserves serve as a hedge against the balance-sheet effect, and their optimal level co-varies with the degree of dollarization. DMTT’s framework, which abstracts from reserves, cannot speak to the joint determination of the exchange-rate regime and reserve policy that is a central feature of emerging-market central banking in practice (Aizenman and Lee, 2007; Jeanne and Rancière, 2011).

5.5.4 An identification problem worth noting

The two financial frictions — endogenous risk premia and liability dollarization — are observationally similar in some respects. Both generate procyclical capital flows, both amplify the response of consumption to commodity shocks, and both contribute to the “fear of floating” pattern documented by Calvo and Reinhart (2002). This raises a methodological concern: in a setting where both frictions are present, the empirical identification of their separate contributions is non-trivial.

DMTT calibrate their risk-premium elasticity to commodity prices using the regression estimates of Drechsel and Tenreyro (2018), which use Argentine data. But Argentina is precisely the case where the balance-sheet channel is most active. If the Drechsel and Tenreyro (2018) estimates of the risk-premium elasticity are partially capturing the balance-sheet channel through reduced-form means, then DMTT’s calibration may be implicitly absorbing some of the dollarization mechanism — just attributing it to the wrong source. This would not undermine DMTT’s qualitative conclusions, but it would suggest that their estimates of the risk-premium channel’s contribution are upward-biased, and that an explicit decomposition would reassign part of the action to the dollarization channel.

Resolving this identification problem requires structural estimation in a model that includes both frictions, with restrictions sufficient to separate them — plausibly, the asymmetry of Prediction 2, or cross-sectional variation in corporate dollarization rates across emerging markets, would provide the identifying moments. This is, in itself, a substantial research agenda.

5.5.5 Summary

The extended framework I am sketching is not a radical departure from DMTT — it is a structurally consistent augmentation that preserves all the elements they emphasise (mixed-currency pricing, endogenous commodity-dependent risk premia, the four-economy taxonomy) while integrating the second financial friction that the third-generation crisis literature has identified as central to emerging-market exchange-rate choice. The result would be a model that delivers DMTT’s findings exactly for advanced economies and low-dollarization emerging economies, but yields qualitatively different prescriptions for high-dollarization emerging economies. This offers a microfounded, welfare-based rationale for the empirical observation that emerging-market commodity exporters historically display managed-float or intermediate regimes more often than the pure float that DMTT’s framework recommends — a rationale that does not rely on credibility deficits or political-economy constraints, but on the underlying structure of private-sector balance sheets.

6. Implications for the policy taxonomy

If the argument in Section 5 is correct, the practical implications are twofold.

First, the explanation DMTT offer for the “fear of floating” in emerging markets — that procyclical risk premia amplify the trade-offs facing the optimal policy — is plausible but incomplete. A more comprehensive account combines their channel with the balance-sheet channel: emerging-market central banks face both a credit-market amplification of commodity shocks and a wealth-transfer mechanism through dollarised private liabilities. The two reinforce each other in the same direction — both discourage flexible exchange rates — but they call for different policy responses. The risk-premium channel can be partly offset through reserve accumulation and counter-cyclical capital flow management (Bianchi, 2011; Korinek, 2018); the balance-sheet channel calls instead for ex-ante macroprudential regulation of currency mismatches and, in extremis, ex-post lender-of-last-resort interventions in dollars (Bocola and Lorenzoni, 2020).

Second, the policy ranking under correlated shocks — DMTT’s result (iv) — is even less robust than the authors suggest. In their framework, the optimal policy under correlated import and export shocks lies between DIT and the peg, with no simple rule dominating. Once liability dollarization is incorporated, the locus of the optimal policy moves toward the peg for high-dollarization economies and toward DIT for low-dollarization economies — introducing a country-specific dimension that the DMTT taxonomy cannot capture. This is consistent with the empirical observation that the six emerging-market economies in their calibration (Argentina, Chile, Ghana, India, Vietnam, Turkey) have in practice adopted markedly different exchange-rate frameworks despite having broadly similar commodity exposures.

7. Conclusion

Drechsel, McLeay, Tenreyro and Turri (2026) is an important paper. The unification of advanced and emerging, importer and exporter cases under a single tractable framework is a methodological achievement, and the extension of the “looking through” doctrine to indirect cost effects is a genuine conceptual advance. The formalisation of endogenous, commodity-dependent risk premia as a structural source of asymmetry between advanced and emerging economies represents the paper’s most original contribution.

These contributions notwithstanding, the explicit omission of liability dollarization is, in my reading, more consequential than the footnoted caveats acknowledge. The third-generation crisis literature — Krugman (1999), Céspedes, Chang and Velasco (2004), Cook (2004) — and its modern extensions — Bocola and Lorenzoni (2020), Coulibaly (2023), Mendoza and Rojas (2019) — have established that balance-sheet effects can reverse the sign of the optimal exchange-rate response in dollarised economies. For commodity exporters facing adverse shocks, this could overturn the paper’s first result. For the broader emerging-market policy taxonomy, it suggests a more textured story than the one DMTT offer: the choice of exchange-rate framework reflects not only the procyclicality of credit conditions, but also the depth of corporate currency mismatches.

The most productive direction for future research, in light of this critique, would be a unified framework that nests both financial frictions — the endogenous external risk premium and the dollarised private-sector balance sheet — and computes optimal policy across the full parameter space. Such a model would clarify which features of the policy-regime choice are driven by which friction, and would give the analytical clarity that this important paper, by its own choice of scope, leaves to subsequent work.

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