Currency Crises and Monetary Policy in an Economy with Credit Constraints

The paper discusses dynamics of private sector debt-to-GDP ratio and debt service ratio (DSR). We show that the level of DSR for developing countries is less than that of DSR for developed countries, and has a more volatile dynamics. Developing countries face significant risk from external sector of the economy due to high level of their dependence on external debt - through currency revaluation, on the one hand, and reciprocal growth of interest rates, on the other hand. This is illustrated, for example, by the situation in Russia in 2014-2016. We also show that countries with monetary policy based on inflation targeting face much more downplayed response of DSR shocks on their economic activity than countries with different regimes of monetary policy. That is why currency crises in several regions including South-East Asia and Russia, have led to significant growth in DSR and forwarded shift to inflation targeting in these countries. Along with shocks of DSR related to volatility of foreign currency, we explore those related to inflation and monetary conditions, abrupt changes in economic activity, etc. The paper also focuses on factors of DSR dynamics, including interest rates, terms, volumes, foreign currency revaluation, and its decomposition on the long period of time.

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Currency Crises, Monetary Policy and Corporate Balance Sheets

German Economic Review ◽

10.1111/j.1468-0475.2007.00410.x ◽

2007 ◽

Vol 8 (3) ◽

pp. 309-343 ◽

Cited By ~ 4

Author(s):

Sylvester C. W. Eijffinger ◽

Benedikt Goderis

Keyword(s):

Monetary Policy ◽

Exchange Rate ◽

Interest Rate ◽

Currency Crises ◽

Balance Sheet ◽

Balance Sheets ◽

Output Loss ◽

Balance Sheet Effects ◽

Loss Compensation ◽

Exchange Rate Changes

Abstract This paper studies how the exposure of a country’s corporate sector to interest rate and exchange rate changes affects the probability of a currency crisis. To analyze this question, we present a model that defines currency crises as situations in which the costs of maintaining a fixed exchange rate exceed the costs of abandonment. The results show that a higher exposure to interest rate changes increases the probability of crisis through an increased need for output loss compensation and an increased efficacy of monetary policy in stimulating output. A higher exposure to exchange rate changes also increases the need for output loss compensation. However, it lowers the efficacy of monetary policy in stimulating output through the adverse balance sheet effects of exchange rate depreciation. As a result, its effect on the probability of crisis is ambiguous.

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