External Constraints on Monetary Policy and the Financial Accelerator

49 Pages Posted: 12 Nov 2008

See all articles by Mark Gertler

Mark Gertler

New York University - Leonard N. Stern School of Business - Department of Economics; National Bureau of Economic Research (NBER)

Simon Gilchrist

Boston University - Department of Economics; National Bureau of Economic Research (NBER)

Fabio M. Natalucci

U.S. Federal Reserve Board - Division of Monetary Affairs

Multiple version iconThere are 3 versions of this paper

Date Written: October 2003

Abstract

We develop a small open economy macroeconomic model where financial conditions influence aggregate behavior. We use this model to explore the connection between the exchange rate regime and financial distress. We show that fixed exchange rates exacerbate financial crises by tying the hands of the monetary authorities. We then investigate the quantitative significance by first calibrating the model to Korean data and then showing that it does a reasonably good job of matching the Korean experience during its recent financial crisis. In particular, the model accounts well for the sharp increase in lending rates and the large drop in output, investment and productivity during the 1997-1998 episode. We then perform some counterfactual exercises to illustrate the quantitative significance of fixed versus floating rates both for macroeconomic performance and for welfare. Overall, these exercises imply that welfare losses following a financial crisis are significantly larger under fixed exchange rates relative to flexible exchange rates.

Keywords: Financial crises, exchange rate policy

Suggested Citation

Gertler, Mark and Gilchrist, Simon and Natalucci, Fabio Massimo, External Constraints on Monetary Policy and the Financial Accelerator (October 2003). NYU Working Paper No. S-MF-03-19. Available at SSRN: https://ssrn.com/abstract=1300222

Mark Gertler (Contact Author)

New York University - Leonard N. Stern School of Business - Department of Economics ( email )

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Simon Gilchrist

Boston University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Fabio Massimo Natalucci

U.S. Federal Reserve Board - Division of Monetary Affairs ( email )

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Washington, DC 20551
United States
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202-736-5638 (Fax)

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