Currency Crises and Monetary Policy in an Economy with Credit Constraints
Harvard University - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)
Abhijit V. Banerjee
Massachusetts Institute of Technology (MIT) - Department of Economics
University of Lausanne; Swiss Finance Institute; Centre for Economic Policy Research (CEPR)
Studienzentrum Gerzensee Working Paper No. 00.07
This paper presents a simple model of currency crises which is driven by the interplay between the credit constraints of private domestic firms and the existence of nominal price rigidities. The possibility of multiple equilibria, including a 'currency crisis' equilibrium with low output and a depreciated domestic currency, results from the following mechanism: if nominal prices are 'sticky', a currency depreciation leads to an increase in the foreign currency debt repayment obligations of firms, and thus to a fall in their profits; this reduces firms' borrowing capacity and therefore investment and output in a credit-constrained economy, which in turn reduces the demand for the domestic currency and leads to a depreciation. We examine the impact of various shocks, including productivity, fiscal, or expectational shocks. We then analyze the optimal monetary policy to prevent or solve currency crises. We also argue that currency crises can occur both under fixed and flexible exchange rate regimes as the primary source of crises is the deteriorating balance sheet of private firms.
Number of Pages in PDF File: 43
Keywords: currency crisis, foreign currency debt, credit constraint
JEL Classification: F3, E44, F41working papers series
Date posted: September 20, 2000
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