DP5905 Supply Shocks and Currency Crises: The Policy Dilemma Reconsidered
|Author(s):||Javier García-Fronti, Marcus Miller, Lei Zhang|
|Publication Date:||October 2006|
|Keyword(s):||contractionary devaluation, financial crises, Keynesian recession, supply and demand shocks|
|JEL(s):||E12, E4, E51, F34, G18|
|Programme Areas:||International Macroeconomics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=5905|
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.