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A Corporate Balance Sheet Approach to Currency Crises

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Author Info
Aghion, Philippe
Bacchetta, Philippe
Banerjee, Abhijit

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Abstract

This Paper presents a general equilibrium currency crisis model of the 'third generation', in which the possibility of currency crises is driven by the interplay between private firms' credit-constraints and nominal price rigidities. Despite our emphasis on microfoundations, the model remains sufficiently simple that the policy analysis can be conducted graphically. The analysis hinges on four main features: i) ex post deviations from purchasing power parity; ii) credit constraints a la Bernanke-Gertler; iii) foreign currency borrowing by domestic firms; iv) a competitive banking sector lending to firms and holding reserves and a monetary policy conducted either through open market operations or short-term lending facilities. We first show that with a positive likelihood of a currency crisis, firms may indeed find it optimal to borrow in foreign currency, following Chamon (2001). Second, we derive sufficient conditions for the existence of a sunspot equilibrium with currency crises. Third, we show that a reduction in the monetary base through restrictive open market operations is more likely to eliminate the possibility of currency crises if at the same time the central bank does not impose excessive constraints on short-term lending facilities.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3092.

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Date of creation: Dec 2001
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Handle: RePEc:cpr:ceprdp:3092

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Keywords: financial crisis foreign currency debt monetary policy

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Find related papers by JEL classification:
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
F30 - International Economics - - International Finance - - - General
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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