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Liability Dollarization and the Bank Balance Sheet Channel

  • David Cook
  • Woon Gyu Choi

Banks in developing economies often face a mismatch in the currency denomination of their liabilities (foreign currency denominated debt) and assets (domestic currency loans to domestic borrowers). We study the effect of this mismatch on business cycles and monetary policy in a sticky-price, dynamic general equilibrium model of a small open economy. We find from the model analysis that a fixed exchange rate rule that stabilizes the balance sheets of banks offers greater stability than an interest rate rule that targets inflation in the sticky-price sector of the economy.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 02/141.

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Length: 26
Date of creation: 01 Aug 2002
Date of revision:
Handle: RePEc:imf:imfwpa:02/141
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  1. Chang, R. & Velasco, A., 1999. "Liquidity Crises in Emerging Markets: Theory and Policy," Working Papers 99-14, C.V. Starr Center for Applied Economics, New York University.
  2. Timothy S. Fuerst & Charles T. Carlstrom, 1998. "Agency costs and business cycles," Economic Theory, Springer, vol. 12(3), pages 583-597.
  3. Carlstrom, Charles T & Fuerst, Timothy S, 1997. "Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis," American Economic Review, American Economic Association, vol. 87(5), pages 893-910, December.
  4. Luis Felipe Cespedes & Roberto Chang & Andres Velasco, 2000. "Balance Sheets and Exchange Rate Policy," NBER Working Papers 7840, National Bureau of Economic Research, Inc.
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