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Currency Crises and Monetary Policy in Economies with Partial Dollarization of Liabilities

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  • Christian Proa~no
  • Peter Flaschel
  • Willi Semmler

Abstract

After the breakdown of aggregate investment observed after the 1997-98 East Asian crisis, in almost all countries which suffered from sharp nominal devaluations, academicians and policymakers have engaged in a hot debate about the adequate monetary policy strategy against a speculative attack on the domestic currency. By means of a simple currency crisis model based on Proa~no, Flaschel and Semmler (2005), this paper shows how an increase in the domestic interest rate by the central bank, as a response to a currency run on the domestic currency, can significantly affect the aggregate demand by depressing the investment of the subsector of domestic firms which are not indebted in foreign currency. Furthermore, it is shown that, in specific scenarios, the strategy adopted by the East Asian countries of domestic interest rate increases might not have been the best response to a speculative attack from the medium term point of view.

Suggested Citation

  • Christian Proa~no & Peter Flaschel & Willi Semmler, 2008. "Currency Crises and Monetary Policy in Economies with Partial Dollarization of Liabilities," The IUP Journal of Monetary Economics, IUP Publications, vol. 0(3), pages 14-39, August.
  • Handle: RePEc:icf:icfjmo:v:06:y:2008:i:3:p:14-39
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    References listed on IDEAS

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    1. Kaminsky, Graciela L. & Reinhart, Carmen M., 2002. "Financial markets in times of stress," Journal of Development Economics, Elsevier, vol. 69(2), pages 451-470, December.
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    11. Andreas Röthig & Willi Semmler & Peter Flaschel, 2009. "Corporate Currency Hedging and Currency Crises," Chapters,in: Recent Advances in Neo-Schumpeterian Economics, chapter 7 Edward Elgar Publishing.
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    Cited by:

    1. Christian R. Proaño, 2013. "Monetary Policy Rules And Macroeconomic Stabilization In Small Open Economies Under Behavioral Fx Trading: Insights From Numerical Simulations," Manchester School, University of Manchester, vol. 81(6), pages 992-1011, December.

    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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