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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 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 over-accumulate 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.
