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Currency Crises and Monetary Policy in an Economy with Credit Constraints

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  • Banerjee, Abhijit
  • Bacchetta, Philippe
  • Aghion, Philippe

Abstract

This paper presents a simple model of currency crises which is driven by the interplay between the credit constraints of private domestic firms and the existence of nominal price rigidities. The possibility of multiple equilibria, including a ‘currency crisis’ equilibrium with low output and a depreciated domestic currency, results from the following mechanism: If nominal prices are ‘sticky’, a currency depreciation leads to an increase in the foreign currency debt repayment obligations of firms, and thus to a fall in their profits; this reduces firms’ borrowing capacity and therefore investment and output in a credit-constrained economy, which in turn reduces the demand for the domestic currency and leads to a depreciation. We examine the impact of various shocks, including productivity, fiscal, or expectational shocks. We then analyze the optimal monetary policy to prevent or solve currency crises. We also argue that currency crises can occur both under fixed and flexible exchange rate regimes as the primary source of crises is the deteriorating balance sheet of private firms.

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File URL: http://dash.harvard.edu/bitstream/handle/1/4554218/aghion_currencycrises.pdf
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Bibliographic Info

Paper provided by Harvard University Department of Economics in its series Scholarly Articles with number 4554218.

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Date of creation: 2001
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Publication status: Published in European Economic Review
Handle: RePEc:hrv:faseco:4554218

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  1. Peter M. Garber & Lars E.O. Svensson, 1994. "The Operation and Collapse of Fixed Exchange Rate Regimes," NBER Working Papers 4971, National Bureau of Economic Research, Inc.
  2. Maurice Obstfeld and Kenneth Rogoff., 1995. "Exchange Rate Dynamics Redux," Center for International and Development Economics Research (CIDER) Working Papers C95-048, University of California at Berkeley.
  3. Philippe Bacchetta, 2000. "Monetary Policy with Foreign Currency Debt," Working Papers 00.03, Swiss National Bank, Study Center Gerzensee.
  4. Jeanne, Olivier, 2000. "Foreign currency debt and the global financial architecture," European Economic Review, Elsevier, vol. 44(4-6), pages 719-727, May.
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  6. Flood, Robert & Marion, Nancy, 1999. "Perspectives on the Recent Currency Crisis Literature," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 4(1), pages 1-26, January.
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  9. Olivier Jeanne & Robert P. Flood, 2000. "An Interest Rate Defense of a Fixed Exchange Rate?," IMF Working Papers 00/159, International Monetary Fund.
  10. Philippe Aghion & Philippe Bacchetta & Abhijit Banerjee, 1999. "A Simple Model of Monetary Pollicy and Currency Crises," Working Papers 99.05, Swiss National Bank, Study Center Gerzensee.
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  1. Links for 2007-10-08 [del.icio.us]
    by (author unknown) in alpha.sources.cv on 2007-10-09 05:00:00
  2. Of Economic Growth and Currency Crises ...
    by CV in alpha.sources.cv on 2007-10-08 19:20:37
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