Debt Overhang and Real Exchange Rate Overshooting in the Asian Crisis

David Vines, Gordon Menzies, Economic Research Department and Reserve Bank of Australia.

No 122, Economics Series Working Papers from University of Oxford, Department of Economics

Abstract: We develop a stylized real model of the Asian crisis where an adverse extenal shock can lead to real exchange rate overshooting. Domestic borrowers of foreign capital are bound by debt contracts even when the capital is unable to earn the world rate of return. Following an adverse shock, the requirement to honour these debt contracts leads to a debt overhang. In the long run, when capital becomes mobile, extra-marginal projects are shut down as capital departs, and the real exchange rate falls by more than the terms of trade shock. In the short run, the real exchange rate is partly determined by demand conditions by means of what we call the wage and overhang multipliers. For reasonable production and consumption parameters, the short run real exchange rate - driven by the wage and overhang multipliers - overshoots its long run value.

Keywords: Asian crisis; exchange rate overshooting; mulitplier; overhang (search for similar items in EconPapers)
JEL-codes: F11 F31 (search for similar items in EconPapers)
Date: 2002-10-01
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Citations: View citations in EconPapers (1)

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