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Currency Crises and Monetary Policy in Economies with Partial Dollarization of Liabilities

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  • Christian Proa~no
  • Peter Flaschel
  • Willi Semmler

Abstract

After the breakdown of aggregate investment observed after the 1997-98 East Asian crisis, in almost all countries which suffered from sharp nominal devaluations, academicians and policymakers have engaged in a hot debate about the adequate monetary policy strategy against a speculative attack on the domestic currency. By means of a simple currency crisis model based on Proa~no, Flaschel and Semmler (2005), this paper shows how an increase in the domestic interest rate by the central bank, as a response to a currency run on the domestic currency, can significantly affect the aggregate demand by depressing the investment of the subsector of domestic firms which are not indebted in foreign currency. Furthermore, it is shown that, in specific scenarios, the strategy adopted by the East Asian countries of domestic interest rate increases might not have been the best response to a speculative attack from the medium term point of view.

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Article provided by IUP Publications in its journal The IUP Journal of Monetary Economics.

Volume (Year): VI (2008)
Issue (Month): 3 (August)
Pages: 14-39

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Handle: RePEc:icf:icfjmo:v:06:y:2008:i:3:p:14-39

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  1. Röthig, Andreas & Semmler, Willi & Flaschel, Peter, 2005. "Corporate currency hedging and currency crises," Darmstadt Discussion Papers in Economics 27194, Darmstadt Technical University, Department of Business Administration, Economics and Law, Institute of Economics (VWL).
  2. Corsetti, G. & Pesenti, P. & Roubini, N., 1998. "What Caused the Asian Currency and Financial Crisis?," Papers 343, Banca Italia - Servizio di Studi.
  3. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  4. Jason Furman & Joseph E. Stiglitz, 1998. "Economic Crises: Evidence and Insights from East Asia," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 1-136.
  5. Guillermo A. Calvo & Frederic S. Mishkin, 2003. "The Mirage of Exchange Rate Regimes for Emerging Market Countries," Journal of Economic Perspectives, American Economic Association, vol. 17(4), pages 99-118, Fall.
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  7. Morris Goldstein & Philip Turner, 2004. "Controlling Currency Mismatches in Emerging Markets," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 373.
  8. Christiano, Lawrence J. & Gust, Christopher & Roldos, Jorge, 2004. "Monetary policy in a financial crisis," Journal of Economic Theory, Elsevier, vol. 119(1), pages 64-103, November.
  9. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange Rates and Financial Fragility," NBER Working Papers 7418, National Bureau of Economic Research, Inc.
  10. Kaminsky, Graciela L. & Reinhart, Carmen M., 2002. "Financial markets in times of stress," Journal of Development Economics, Elsevier, vol. 69(2), pages 451-470, December.
  11. Steven Radelet & Jeffrey Sachs, 1998. "The Onset of the East Asian Financial Crisis," NBER Working Papers 6680, National Bureau of Economic Research, Inc.
  12. Paul Krugman, 2000. "Crises : the price of globalization?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 75-106.
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