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

U. Michael Bergman and Shakill Hassan
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U. Michael Bergman: Department of Economics, University of Copenhagen

No 08-01, EPRU Working Paper Series from Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics

Abstract: 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.

Keywords: currency crises; foreign–currency debt; balance sheets; interest parity; monetary policy (search for similar items in EconPapers)
JEL-codes: E51 F30 O11 (search for similar items in EconPapers)
Pages: 18 pages
Date: 2008-05
New Economics Papers: this item is included in nep-cba, nep-ifn, nep-mac, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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