DP8938 Debt Deleveraging and the Exchange Rate

Author(s): Pierpaolo Benigno, Federica Romei
Publication Date: April 2012
Keyword(s): Current Account adjustment
JEL(s): E40
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8938

Deleveraging from high debt can provoke deep recession with significant international side effects. The exchange rate of the deleveraging country will depreciate in the short run and appreciate in the long run. The real interest rate will fall by more than in the rest of the world. Bounds and policies that constrain the adjustment can prolong and deepen the recession. Early exit strategies from accommodating monetary policy can be quite harmful, as can such other policies as keeping interest rates too high during the deleveraging period. The analysis also applies to a monetary union facing internal adjustment of current account imbalances.