Hedging and Financial Fragility in Fixed Exchange Rate Regimes

58 Pages Posted: 9 Jun 1999

See all articles by A. Craig Burnside

A. Craig Burnside

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

Martin Eichenbaum

Northwestern University; National Bureau of Economic Research (NBER)

Sergio T. Rebelo

Northwestern University - Kellogg School of Management; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: May 1999

Abstract

Currency crises that coincide with banking crises tend to share four elements. First, governments provide guarantees to domestic and foreign bank creditors. Second, banks do not hedge their exchange rate risk. Third, there is a lending boom before the crises. Finally, when the currency/banking collapse occurs interest rates rise and there is a persistent decline in output. This paper proposes an explanation for these regularities. We show that government guarantees lower interest rates, and generate an economic boom. But they also lead to a more fragile banking system: banks choose not to hedge exchange rate risk. When the fixed exchange rate is abandoned in favor of a crawling peg banks go bankrupt, the domestic interest rate rises, real wages fall and output declines.

JEL Classification: F31, F41, G15, G21

Suggested Citation

Burnside, Craig and Eichenbaum, Martin and Tavares Rebelo, Sergio, Hedging and Financial Fragility in Fixed Exchange Rate Regimes (May 1999). FRB Chicago Working Paper No. #. Available at SSRN: https://ssrn.com/abstract=164443 or http://dx.doi.org/10.2139/ssrn.164443

Craig Burnside

Duke University - Department of Economics ( email )

213 Social Sciences Building
Box 90097
Durham, NC 27708-0204
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University of Glasgow - Department of Economics

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Glasgow, Scotland G12 8RT
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National Bureau of Economic Research (NBER)

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Martin Eichenbaum

Northwestern University ( email )

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United States
847-491-8232 (Phone)
847-491-7001 (Fax)

National Bureau of Economic Research (NBER)

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Sergio Tavares Rebelo (Contact Author)

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Leverone Hall
Evanston, IL 60208
United States
847-467-2329 (Phone)
847-491-5719 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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