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Financing Decisions of Firms and Central Bank Policy

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  • Goh, Ai Ting
  • Olivier, Jacques
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    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.

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    Bibliographic Info

    Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3110.

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    Date of creation: Nov 2001
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    Handle: RePEc:cpr:ceprdp:3110

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    Related research

    Keywords: Asian Crisis; central bank; foreign borrowing;

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    1. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
    2. Maurice Obstfeld, 1994. "The Logic of Currency Crises," NBER Working Papers 4640, National Bureau of Economic Research, Inc.
    3. Steven Radelet & Jeffrey Sachs, 1998. "The Onset of the East Asian Financial Crisis," NBER Working Papers 6680, National Bureau of Economic Research, Inc.
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