Growth Effects in a Stochastic Model of Currency Crisis

UCSC Dept. of Econ. Working Paper No. 481

35 Pages Posted: 26 Oct 2001

Date Written: September 22, 2001

Abstract

The main contributions of this paper are to introduce growth into a crisis framework and to derive the contingency plans for consumption and investment in a manner consistent with the stochastic nature of the state of the economy. The conclusion is that expected deviations from trend in the future rate of depreciation do reduce domestic investment and growth. Empirical evidence in support of this idea is also presented. While the intuition behind the "crowding out" effect of expected increases in government spending on domestic investment is familiar to any student of intermediate macroeconomics, formalizing this notion in the context of a crisis is an important step towards understanding a potential source of output losses. An implicit assumption is that markets of contingent claims are incomplete, so that private agents are unable to insure away the adverse income effects of the fiscal expansion.

Keywords: Stochastic model, growth, currency crisis

JEL Classification: C61, E63, F31, F43

Suggested Citation

Shankar, Rashmi, Growth Effects in a Stochastic Model of Currency Crisis (September 22, 2001). UCSC Dept. of Econ. Working Paper No. 481, Available at SSRN: https://ssrn.com/abstract=288347 or http://dx.doi.org/10.2139/ssrn.288347

Rashmi Shankar (Contact Author)

World Bank ( email )

1818 H Street N.W.
Washington, DC 20433
United States

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