Currency Crises and Monetary Policy in an Economy with Credit Constraints: The No Interest Parity Case

TY - UNPB

T1 - Currency Crises and Monetary Policy in an Economy with Credit Constraints

T2 - The No Interest Parity Case

AU - Bergman, Ulf Michael

AU - Hassan, Shakill

N1 - JEL classification: E51, F30, O11

PY - 2008

Y1 - 2008

N2 - This paper revisits the currency crises model of Aghion, Bacchetta and Banerjee (2000, 2001, 2004), who show that if there exist nominal price rigidities and private sector credit constraints, and the credit multiplier depends on real interest rates, then the optimal monetary policy response to the threat of a currency crisis is restrictive. We demonstrate that this result is primarily due to the uncovered interest parity assumption. Assuming that the exchange rate is a martingale restores the case for expansionary reaction - even with foreign-currency debt in firms' balance sheets. The effect of lower interest rates on output can help restore the value of the currency due to increased money demand

AB - This paper revisits the currency crises model of Aghion, Bacchetta and Banerjee (2000, 2001, 2004), who show that if there exist nominal price rigidities and private sector credit constraints, and the credit multiplier depends on real interest rates, then the optimal monetary policy response to the threat of a currency crisis is restrictive. We demonstrate that this result is primarily due to the uncovered interest parity assumption. Assuming that the exchange rate is a martingale restores the case for expansionary reaction - even with foreign-currency debt in firms' balance sheets. The effect of lower interest rates on output can help restore the value of the currency due to increased money demand

KW - Faculty of Social Sciences

KW - foreign-currency debt

KW - balance sheets

M3 - Working paper

BT - Currency Crises and Monetary Policy in an Economy with Credit Constraints

PB - Economic Policy Research Unit. Department of Economics, University of Copenhagen

ER -