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A corporate Balance-Sheet Approach to Currency Crises

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Author Info
Philippe Aghion () (Harvard University, University College London, and CEPR)
Philippe Bacchetta () (University of Lausanne, Studienzentrum Gerzensee, and CEPR)
Abhijit Banerjee () (Massachusetts Institute of Technology)

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Abstract

The paper presents a general equilibrium currency crises 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 two 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 crises, firms may indeed find it optimal to borrow in foreign currency, following Chamon (2001). Second, we derive sufficient conditions for the existence of 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 poaaibility 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 Swiss National Bank, Study Center Gerzensee in its series Working Papers with number 01.05.

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Length: 42 pages
Date of creation: Nov 2001
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Handle: RePEc:szg:worpap:0105

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  8. Aghion, Philippe & Bacchetta, Philippe & Banerjee, Abhijit, 2001. "Currency crises and monetary policy in an economy with credit constraints," European Economic Review, Elsevier, vol. 45(7), pages 1121-1150. [Downloadable!] (restricted)
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  33. Panizza, U. & Stein, E.H. & Hausmann, R., 2000. "Why Do Countries Float the Way They Float?," RES Working Papers 418, Inter-American Development Bank, Research Department.
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