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Currency Crises and Monetary Policy in an Economy with Credit Constraints

Listed author(s):
  • Banerjee, Abhijit
  • Bacchetta, Philippe
  • Aghion, Philippe

This paper presents a simple model of currency crises which is driven by the interplay between the credit constraints of private domestic firms and the existence of nominal price rigidities. The possibility of multiple equilibria, including a ‘currency crisis’ equilibrium with low output and a depreciated domestic currency, results from the following mechanism: If nominal prices are ‘sticky’, a currency depreciation leads to an increase in the foreign currency debt repayment obligations of firms, and thus to a fall in their profits; this reduces firms’ borrowing capacity and therefore investment and output in a credit-constrained economy, which in turn reduces the demand for the domestic currency and leads to a depreciation. We examine the impact of various shocks, including productivity, fiscal, or expectational shocks. We then analyze the optimal monetary policy to prevent or solve currency crises. We also argue that currency crises can occur both under fixed and flexible exchange rate regimes as the primary source of crises is the deteriorating balance sheet of private firms.

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File URL: http://dash.harvard.edu/bitstream/handle/1/4554218/aghion_currencycrises.pdf
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Paper provided by Harvard University Department of Economics in its series Scholarly Articles with number 4554218.

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Date of creation: 2001
Publication status: Published in European Economic Review
Handle: RePEc:hrv:faseco:4554218
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  10. Aghion, Philippe & Bacchetta, Philippe & Banerjee, Abhijit, 2000. "A simple model of monetary policy and currency crises," European Economic Review, Elsevier, vol. 44(4-6), pages 728-738, May.
  11. Ben S. Bernanke & Mark Gertler, 1995. "Inside the Black Box: The Credit Channel of Monetary Policy Transmission," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 27-48, Fall.
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  13. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics,in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier.
  14. Flood, Robert P. & Jeanne, Olivier, 2005. "An interest rate defense of a fixed exchange rate?," Journal of International Economics, Elsevier, vol. 66(2), pages 471-484, July.
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  17. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
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  19. Jeanne, Olivier, 2000. "Foreign currency debt and the global financial architecture," European Economic Review, Elsevier, vol. 44(4-6), pages 719-727, May.
  20. Flood, Robert & Marion, Nancy, 1999. "Perspectives on the Recent Currency Crisis Literature," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 4(1), pages 1-26, January.
  21. Philippe Bacchetta, 2000. "Monetary Policy with Foreign Currency Debt," Working Papers 00.03, Swiss National Bank, Study Center Gerzensee.
  22. Seppo Honkapohja & Erkki Koskela, 1999. "The economic crisis of the 1990s in Finland," Economic Policy, CEPR;CES;MSH, vol. 14(29), pages 399-436, October.
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  24. Giancarlo Corsetti & Paolo Pesenti & Nouriel Roubini, 1998. "What Caused the Asian Currency and Financial Crisis? Part I: A Macroeconomic Overview," NBER Working Papers 6833, National Bureau of Economic Research, Inc.
  25. E Falcetti & S Milner, 1999. "The Currency Denomination of Public Debt and the Choice of the Monetary Regime," CEP Discussion Papers dp0427, Centre for Economic Performance, LSE.
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  28. Jason Furman & Joseph E. Stiglitz, 1998. "Economic Crises: Evidence and Insights from East Asia," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 1-136.
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