Hedging and Financial Fragility in Fixed Exchange Rate Regimes

59 Pages Posted: 5 Sep 2000 Last revised: 12 Oct 2010

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. 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.

Suggested Citation

Burnside, Craig and Eichenbaum, Martin and Tavares Rebelo, Sergio, Hedging and Financial Fragility in Fixed Exchange Rate Regimes (May 1999). NBER Working Paper No. w7143. Available at SSRN: https://ssrn.com/abstract=227342

Craig Burnside (Contact Author)

Duke University - Department of Economics ( email )

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University of Glasgow - Department of Economics

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Martin Eichenbaum

Northwestern University ( email )

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National Bureau of Economic Research (NBER)

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Sergio Tavares Rebelo

Northwestern University - Kellogg School of Management ( email )

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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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