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Exchange Rate Regime And A Household’s Choice Of Debt

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Abstract

The present paper looks at the impact of exchange rate regime and a household’s choice of debt. One of the characteristics of economic transition in eastern European countries has been an increase in overall debt holding. Standard economic theory assumes the relationship S=I. According to this relationship, households should use debt only to purchase durable goods; however, in some eastern European countries, there has been a large increase in consumer loans, economic behavior not recognized under the standard no-Ponzi scheme assumption of economic models. This paper aims to investigate the case when debt is used to live above a household’s standard budget constraint. Our model shows that the significant impact on the choice of the amount the debt households are willing to hold is due to the choice of the exchange rate regime made by the central bank. The model investigates a household’s behavior in two main cases: a stable exchange rate regime (exchange rate regime with FX risk) and a variable exchange rate regime (exchange rate regime without exchange rate risk). Households make different choices under alternative exchange rate regimes; this pattern of behavior is presented in the model and verified by the data.

Suggested Citation

  • Neven Vidakovic, 2015. "Exchange Rate Regime And A Household’s Choice Of Debt," Effectus - Working Paper Series 0001, Effectus - University College for Law and Finance.
  • Handle: RePEc:eff:wpaper:0001
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    Keywords

    credit; exchange rate; dynamic programming;

    JEL classification:

    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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