Financing Decisions of Firms and Central Bank Policy

33 Pages Posted: 15 Jan 2002

See all articles by Ai-Ting Goh

Ai-Ting Goh

HEC Paris - Economics & Decision Sciences

Jacques Olivier

HEC Paris - Finance Department; Centre for Economic Policy Research (CEPR)

Date Written: November 2001

Abstract

This Paper aims to explain the sharp rise in unhedged foreign borrowing by South East Asian corporations in the few years prior to the crisis despite remarkably little change in fundamentals. The crucial element of our story is the complementarity between decisions of firms and of the central bank, which gives rise to multiple equilibria: when firms use foreign borrowing, they raise the cost of devaluation to the central bank, which in turn makes foreign borrowing more attractive. Consequently, a small shock to fundamentals may move the economy from a region of parameter values where no foreign borrowing is one of multiple possible equilibria to a region where high foreign borrowing is the only equilibrium, thus generating a large and permanent change of the equilibrium composition of firms' borrowing. While this possibility arises even when all firms behave competitively, we show that the impact on foreign borrowing is exacerbated by strategic behaviour of firms.

Keywords: Foreign borrowing, central bank, Asian crisis

JEL Classification: E58, F34

Suggested Citation

Goh, Ai-Ting and Olivier, Jacques, Financing Decisions of Firms and Central Bank Policy (November 2001). CEPR Discussion Paper No. 3110. Available at SSRN: https://ssrn.com/abstract=296867

Ai-Ting Goh (Contact Author)

HEC Paris - Economics & Decision Sciences ( email )

Paris
France
(33 1) 39 67 72 06 (Phone)
(33 1) 39 67 70 85 (Fax)

Jacques Olivier

HEC Paris - Finance Department ( email )

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
France
+33 1 3967 7297 (Phone)
+33 1 3967 7085 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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