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Destabilizing Balance Sheet Effects in the New Consensus Model

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  • Emiliano Libman

    (CIMaD and Business School, Universidad de General San Martín)

Abstract

This paper proposes a simple modification of an otherwise standard New Consensus open economy model. We include an endogenous risk premium to show that a Taylor Rule that satisfies the Taylor Principle may lead to instability if exchange rate depreciations worsen the balance sheet of firms, exerting a negative effect on output and employment. Thus, the adoption of Inflation Targeting and a flexible exchange rate regime introduces destabilizing forces in economies that are exposed to liability dollarization, and this helps to rationalize central bank interventions in the foreign exchange market to avoid large exchange rate fluctuations.

Suggested Citation

  • Emiliano Libman, 2019. "Destabilizing Balance Sheet Effects in the New Consensus Model," Eastern Economic Journal, Palgrave Macmillan;Eastern Economic Association, vol. 45(4), pages 590-611, October.
    • Handle: RePEc:pal:easeco:v:45:y:2019:i:4:d:10.1057_s41302-019-00146-3
    DOI: 10.1057/s41302-019-00146-3
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    More about this item

    Keywords

    Inflation targeting; Balance sheet effects; Liability dollarization; Contractionary devaluations; Financial accelerator;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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