Firm Liquidation and Economic Crisis under Unexpected Exchange Rate Shock

Qiang Gong, Shen Jia and Justin Lin ()
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Shen Jia: China Center for Economic Research, Peking University

Annals of Economics and Finance, 2009, vol. 10, issue 1, 1-14

Abstract: This paper studies the causes, mechanisms and consequences of decreasing firm value and welfare loss in an economy under a fixed exchange rate regime when there is an unexpected appreciation in domestic currency. We also study the possible economic crisis caused by the exchange rate shock. We consider the established production capacity as well as the training of firmspecific labors before production to obtain that unexpected appreciation in domestic currency leads to unemployment of firm workers as well as a decrease in the firm¡¯s output and revenue. Furthermore, when the exchange rate appreciates to a certain degree, it is likely to induce economic crisis¡ªfirms will stop production completely which will not only decrease the firm¡¯s value, but also create a greater loss of social welfare due to the waste of existing capacity and human capital in the economy. Our study also implies that when an economy shifts from a fixed exchange rate regime to a more flexible one, government could adopt gradual reform policies and partial deregulation of the exchange rate to reduce or prevent social welfare loss when domestic currency faces appreciation pressure.

Keywords: Exchange shocks; Firm liquidation; Financial crisis (search for similar items in EconPapers)
JEL-codes: D21 F31 L51 O12 (search for similar items in EconPapers)
Date: 2009
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Citations: View citations in EconPapers (1)

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