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External constraints on monetary policy and the financial accelerator

  • Mark Gertler

    (New York University - Department of Economics)

  • Simon Gilchrist

    (Boston University - Department of Economics)

  • Fabio M. Natalucci

    (U.S. Federal Reserve Board - Division of Monetary Affairs)

We develop a small open economy macroeconomic model where financial conditions influence aggregate behavior. We use this model to explore the connection between the exchange rate regime and financial distress. Fixed exchange rates are shown to exacerbate financial crises. Quantitative exercises calibrated to match the Korean experience during the recent Asian crisis are able to replicate key macroeconomic outcomes including the sharp increase in lending rates and the observed drop in output, investment and productivity during the 1997-1998 episode. These exercises imply that welfare losses following a financial crisis are significantly larger under fixed exchange rates relative to flexible exchange rates.

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Paper provided by Bank for International Settlements in its series BIS Working Papers with number 139.

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Length: 61 pages
Date of creation: Sep 2003
Date of revision:
Handle: RePEc:bis:biswps:139
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