Discussion Paper Details

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Title: Supply Shocks and Currency Crises: The Policy Dilemma Reconsidered

Author(s): Javier García-Fronti, Marcus Miller and Lei Zhang

Publication Date: October 2006

Keyword(s): contractionary devaluation, financial crises, Keynesian recession and supply and demand shocks

Programme Area(s): International Macroeconomics

Abstract: The stylised facts of currency crises in emerging markets include output contraction coming hard on the heels of devaluation, with a prominent role for the adverse balance-sheet effects of liability dollarisation. In the light of the South East Asian experience, we propose an eclectic blend of the supply-side account of Aghion, Bacchetta and Banerjee (2000) with a demand recession triggered by balance sheet effects (Krugman, 1999). This sharpens the dilemma facing the monetary authorities - how to defend the currency without depressing the economy. But, with credible commitment or complementary policy actions, excessive output losses can, in principle, be avoided.

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Bibliographic Reference

García-Fronti, J, Miller, M and Zhang, L. 2006. 'Supply Shocks and Currency Crises: The Policy Dilemma Reconsidered'. London, Centre for Economic Policy Research.