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External constraints on monetary policy and the financial accelerator

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Listed:
  • Mark Gertler
  • Simon Gilchrist
  • Fabio M. Natalucci

Abstract

This paper incorporates a financial accelerator mechanism in a small open economy macro model with money and nominal price rigidities. Our goal is to explore the connection between financial distress that feeds into the real economy and the exchange rate regime. Our principle finding is that financial accelerator effects are much stronger under fixed rates than under flexible rates (with a suitably managed monetary policy). Roughly speaking, an exchange rate peg forces the central bank to adjust the interest rate in a manner that enhances the financial distress. This occurs even when debt is denominated in units of foreign currency. Finally, unexpectedly delaying the abandonment of an exchange rate peg several quarters after a shock can produce distress nearly as bad as occurs under a permanent peg, due to the unanticipated contractions in asset prices.

Suggested Citation

  • Mark Gertler & Simon Gilchrist & Fabio M. Natalucci, 2001. "External constraints on monetary policy and the financial accelerator," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
    • Handle: RePEc:fip:fedfpr:y:2001:i:mar:x:4
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    More about this item

    Keywords

    Foreign exchange rates; Monetary policy;

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • F3 - International Economics - - International Finance

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