Currency Crises and Monetary Policy in an Economy with Credit Constraints: The No Interest Parity Case
AbstractThis paper revisits the currency crises model of Aghion, Bacchetta and Banerjee (2000, 2001, 2004), who show that if there exist nominal price rigidities and private sector credit constraints, and the credit multiplier depends on real interest rates, then the optimal monetary policy response to the threat of a currency crisis is restrictive. We demonstrate that this result is primarily due to the uncovered interest parity assumption. Assuming that the exchange rate is a martingale restores the case for expansionary reaction - even with foreign-currency debt in firms' balance sheets. The effect of lower interest rates on output can help restore the value of the currency due to increased money demand.
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Bibliographic InfoPaper provided by Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics in its series EPRU Working Paper Series with number 08-01.
Length: 18 pages
Date of creation: May 2008
Date of revision:
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currency crises; foreign–currency debt; balance sheets; interest parity; monetary policy;
Find related papers by JEL classification:
- E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
- F30 - International Economics - - International Finance - - - General
- O11 - Economic Development, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-05-24 (All new papers)
- NEP-CBA-2008-05-24 (Central Banking)
- NEP-IFN-2008-05-24 (International Finance)
- NEP-MAC-2008-05-24 (Macroeconomics)
- NEP-MON-2008-05-24 (Monetary Economics)
- NEP-OPM-2008-05-24 (Open Economy Macroeconomic)
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- Shakill Hassan & Sean Smith, 2011. "The Rand as a Carry Trade Target: Risk, Returns and Policy Implications," Working Papers 235, Economic Research Southern Africa.
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