Exchange-Rate-Based Stabilization: A Model of Financial Fragility

Yuri Sobolev

No 2000/122, IMF Working Papers from International Monetary Fund

Abstract: Interactions between banks and open capital account are investigated as rationalizations for empirical regularities characterizing disinflation programs anchored by the exchange rate. The financial system is characterized by bank dominance and lending externality – banks do not internalize the effect of their lending on other banks’ information about potential borrowers. Model dynamics simulation shows that remonetization in the wake of disinflation increases loanable funds supply and translates into bank credit expansion financed by capital inflows. A credit-driven boom results, accompanied by overvaluation and current account deficits generating financial fragilities and vulnerability to a shock that can trigger banking and balance-of-payments crises.

Keywords: WP; central bank; trade balance; exchange rate; Exchange-Rate-Based Stabilization; Credible Disinflation; Bank Intermediation; Financial Fragility; nominal exchange rate; survival probability; cash flow; rate of inflation; bank survival probability; goods sector; market imperfection; bank money creation; central bank lending; borrowing decision; Currencies; Bank credit; Commercial banks; Capital inflows; Consumption; Eastern Europe (search for similar items in EconPapers)
Pages: 36
Date: 2000-06-01
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Citations: View citations in EconPapers (1)

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