Currency Crises and Monetary Policy in an Economy with Credit Constraints

By Philippe Aghion, Philippe Bacchetta, Abhijit Banerjee. 2001

614 citations recorded by the source corpus.

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.

Subfields: Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/03a894e16f46722bebe4f1456409f74933bd9f40

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Citations in the corpus

Political Relationships, Global Financing and Corporate Transparency: Evidence from Indonesia (2006, neutral): “The macroeconomic literature on financial crises distinguishes two effects of currency devaluations: a drop in ‘‘net worth,’’ which weakens firms’ balance sheet positions, and a competitiveness effect which improves financial performance (Krugman, 1999; Aghion et al., 2001).”
Capital Controls and the International Transmission of U.S. Money Shocks (2003, background): “Several studies, including Aghion et al. (2000) and Hausmann et al. (2001), have stressed that foreign currency liabilities are an important explanation why countries with de jure oats may work hard to smooth exchange rate uctuations. Finally, trade openness is measured as the sum of exports to th”
Indicators of Financial Crises Do Work! An Early-warning System for Six Asian Countries (2003, neutral): “…crises stimulated the theoretical and empirical literature on the economics of the crises in several ways, among other things on the determinants of a crisis (Kaminsky and Reinhart, 1999), its impact on domestic output (Aghion, Bacchetta, and Banerjee, 2001), and policy implications (Rogoff, 1999).”
Credible Commitment to Optimal Escape from a Liquidity Trap: The Role of the Balance Sheet of an Independent Central Bank (2004, neutral): “Using equations (4.1), (4.2), and the interest parity condition, ei1 = er S2=S1, the change in capital of the central bank between period 1 and period 2 is given by V2 = V1 + (e i1 1)S1R1 Z2: 11 Note the contrast with the currency mismatches that are the focus of the recent literature on internation”
Liquidity Needs and Vulnerability to Financial Underdevelopment (2003, neutral): “See Aghion et al. (2000).”
Government Bonds in Domestic and Foreign Currency : The Role of Institutional and Macroeconomic Factors (2007, neutral): “This mismatch increases the likelihood of financial crises and may make self-fulfilling runs possible (see, for example, Krugman 1999, Jeanne 2000, Aghion, Bacchetta, and Banerjee 2001, and Schneider and Tornell 2004).”
Capital Structure and Financial Risk: Evidence from Foreign Debt Use in East Asia (2003, background): “For example, if firms had unwisely used excessive amounts of foreign debt prior to the currency crisis, as Krugman (1999) and Aghion et al. (2001) suggest, then these firms should perform relatively worse during or after the exchange 39 See, for example, Claessens et al. (2002), Claessens et al.…”
Systemic Sudden Stops: The Relevance of Balance-Sheet Effects and Financial Integration (2008, neutral): “Another scenario is given in Aghion, Bacchetta, and Banerjee (2001), a paper that is close in spirit to the present discussion because it specifically analyzes the effects of liability dollarization.”
A corporate balance-sheet approach to currency crises (2001, neutral): “By using (5), interest parity and the deÞnition of eθt, we then Þnd: (1 + i∗l t ) = 1 + i∗ 1− qt · 1− qt(1− φ) σ(1 + μ)”
The New Economics of Prudential Capital Controls: A Research Agenda (2011, background): “In standard monetary models with passive monetary policy (such as Mundell-Fleming), declines in aggregate demand reduce money demand and therefore depreciate the exchange rate, as in Aghion, Bacchetta, and Banerjee (2001).”
Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach* (2012, background): “The views expressed in the article are those of the authors and are not necessarily reflective of views at the Federal Reserve Bank of New York or the Federal Reserve System.”