Currency Crises and Monetary Policy in an Economy with Credit Constraints

Philippe Bacchetta, Philippe Aghion and Abhijit Banerjee

No 2529, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: 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 analyse 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.

Keywords: Currency crisis; Foreign currency debt; Credit constraint (search for similar items in EconPapers)
JEL-codes: E44 F30 F41 (search for similar items in EconPapers)
Date: 2000-08
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Citations: View citations in EconPapers (68)

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Related works:
Journal Article: Currency crises and monetary policy in an economy with credit constraints (2001)
Working Paper: Currency Crises and Monetary Policy in an Economy with Credit Constraints (2001)
Working Paper: Currency Crises and Monetary Policy in an Economy with Credit Constraints (2000)
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