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Financial Crises, Monetary Policy and Financial Fragility; A Second-Generation Model of Currency Crises

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Author Info
Eijffinger, Sylvester C W
Goderis, Benedikt

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Abstract

In this Paper we present a model that combines the second-generation trade-off between costs of maintenance and abandonment with possible balance-sheet problems in the corporate sector. We show how debt levels can move a small economy from a fixed exchange rate to a floating exchange rate equilibrium or vice versa, simply by altering the trade-off faced by the monetary authorities. Even if the monetary authorities still have a substantial amount of foreign reserves available to guarantee the fixed value of the currency, they might choose not to and abandon the fixed exchange rate regime. Although it is often argued that first- and second-generation literature have not been able to explain the crisis in East Asia (1997-98), our model suggests that adding corporate balance sheet positions to second-generation models could substantially improve the explanatory power of these models in the case of the Asian crisis.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3637.

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Date of creation: Nov 2002
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Handle: RePEc:cpr:ceprdp:3637

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Related research
Keywords: asian crisis; currency crises; financial crises; financial fragility; monetary policy;

Find related papers by JEL classification:
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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    Other versions:
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    Other versions:
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    Other versions:
  5. Roberto Chang & Andres Velasco, 1998. "The Asian Liquidity Crisis," NBER Working Papers 6796, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  6. Bernanke, B. & Gertler, M. & Gilchrist, S., 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," Working Papers 98-03, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
    Other versions:
  7. Maurice Obstfeld, 1994. "The Logic of Currency Crises," NBER Working Papers 4640, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  17. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June. [Downloadable!] (restricted)
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  18. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August. [Downloadable!] (restricted)
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  20. Giancarlo Corsetti & Paolo Pesenti & Nouriel Roubini, 1998. "What Caused the Asian Currency and Financial Crisis? Part II: The Policy Debate," NBER Working Papers 6834, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  22. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June. [Downloadable!] (restricted)
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    Other versions:
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