Debt Overhang, Exchange Rates and the Macroeconomics of Carry Trade

75 Pages Posted: 23 Jan 2017 Last revised: 18 Jun 2018

See all articles by Egle Jakucionyte

Egle Jakucionyte

University of Amsterdam, Faculty of Economics and Business (FEB), Students

Sweder van Wijnbergen

Universiteit van Amsterdam; Tinbergen Institute; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Date Written: January 2017

Abstract

The depreciation of the Hungarian forint in 2009 left Hungarian borrowers with a skyrocketing value of foreign currency debt. The resulting losses worsened debt overhang in debt-ridden firms and eroded bank capital. Although Hungarian banks had partially hedged exchange rate risk by extending FX-denominated loans, the ensuing debt overhang in borrowing firms exposed the banks to elevated exchange rate correlated credit risk in the run-up to an anticipated Euro adoption. This example of carry trade in emerging Europe motivates our analysis of currency mismatch losses in different sectors in the economy, and the macroconsequences of reallocating losses from the corporate to the banking sector ex post. We develop a small open economy New Keynesian DSGE model that links currency depreciation to corporate debt overhang and incorporates an active banking sector with financial frictions. The model, calibrated to the Hungarian economy, shows that after an unanticipated depreciation allocating currency mismatch losses to the banking sector generates a milder recession than if currency mismatch is placed at credit constrained firms. The government can intervene to reduce aggregate losses even further by recapitalizing banks and thus mitigating the effects of currency mismatch losses on credit supply.

Keywords: Debt overhang, foreign currency debt, Hungary, leveraged banks, small open economy

JEL Classification: E44, F41, P2

Suggested Citation

Jakucionyte, Egle and van Wijnbergen, Sweder, Debt Overhang, Exchange Rates and the Macroeconomics of Carry Trade (January 2017). CEPR Discussion Paper No. DP11788. Available at SSRN: https://ssrn.com/abstract=2904309

Egle Jakucionyte (Contact Author)

University of Amsterdam, Faculty of Economics and Business (FEB), Students ( email )

Amsterdam
Netherlands

Sweder Van Wijnbergen

Universiteit van Amsterdam ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands
+31 20 525 4011 / 4203 (Phone)
+31-35-624 91 82 (Fax)

Tinbergen Institute

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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