Caballero, Ricardo and Krishnamurthy, Arvind (2005): Exchange Rate Volatility and the Credit Channel in Emerging Markets: A Vertical Perspective. Published in: International Journal of Central Banking , Vol. Volume, No. Number 1 : pp. 207-245.
Download (289Kb) | Preview
Firms in emerging markets are exposed to severe financial frictions and credit constraints that are exacerbated by the sudden stop of capital inflows. Can monetary policy offset this external credit squeeze? We show that although this may be the case during moderate contractions (or in partial equilibrium), the expansionary effect of monetary policy vanishes during severe external crises. The exchange rate jumps to reduce the dollar value of domestic collateral until equilibrium in domestic financial markets is consistent with the external constraint. An expansionary monetary policy in this context raises the value of domestic collateral, but it exacerbates the exchange rate depreciation (beyond the standard interest parity effect) and has little effect on aggregate activity. However, there is a dynamic linkage between monetary policy and sudden stops. The anticipation of a dogged defense of the exchange rate worsens the consequences of sudden stops by distorting the private sector incentive to take precautions against these shocks. For similar general equilibrium reasons, dollarization of liabilities has limited impact during a sudden stop, but it has significant underinsurance consequences.
|Item Type:||MPRA Paper|
|Original Title:||Exchange Rate Volatility and the Credit Channel in Emerging Markets: A Vertical Perspective|
|Subjects:||G - Financial Economics > G0 - General > G00 - General
G - Financial Economics > G0 - General
|Depositing User:||Terry Woodard|
|Date Deposited:||14. Nov 2006|
|Last Modified:||17. Feb 2013 17:39|
Aghion, Philippe, Philippe Bacchetta, and Abhijit Banerjee. 2000. “Currency Crises and Monetary Policy with Credit Constraints.” Mimeo, Harvard University.
Bernanke, Ben, and Mark Gertler. 1995. “Inside the Black Box: The Credit Channel of Monetary Policy Transmission.” Journal of Economic Perspectives 9 (Fall): 27–48.
Bernanke, Ben, Mark Gertler, and Simon Gilchrist. 1999. “The Financial Accelerator in a Quantitative Business Cycle Framework.”
In Handbook of Macroeconomics, Vol. 1C, ed. John B. Taylor and Michael Woodford. Elsevier Science.
Bleakley, Hoyt, and Kevin Cowan. 2002. “Corporate Dollar Debt and Depreciations: Much Ado About Nothing?” Working Paper 02-05, Federal Reserve Bank of Boston.
Broner, Fernando, Guido Lorenzoni, and Sergio Schmukler. 2003. “Why do Emerging Markets Borrow Short Term?” Mimeo.
Bulow, Jeremy, and Kenneth Rogoff. 1989. “A Constant Recontracting Model of Sovereign Debt.” Journal of Political Economy 97 (1): 155–78.
Caballero, Ricardo J., and Arvind Krishnamurthy. 2001. “International and Domestic Collateral Constraints in a Model of Emerging Market Crises.” Journal of Monetary Economics 48:513–48.
Caballero, Ricardo J., and Arvind Krishnamurthy. 2003. “Excessive Dollar Debt: Underinsurance and Domestic Financial Underdevelopment.” Journal of Finance 58 (2): 867–93.
Caballero, Ricardo J., and Arvind Krishnamurthy. 2005. “Inflation Targeting and Sudden Stops.” In The Inflation-Targeting Debate, ed. Ben S. Bernanke and Michael Woodford. Chicago: University of Chicago Press.
Calvo, Guillermo A., and Carmen M. Reinhart. 2003. “Fear of Floating.” Quarterly Journal of Economics 117 (2): 379–408.
Cespedes, Luis F., Robert Chang, and Andres Velasco. 2000. “Balance Sheets and Exchange Rate Policy.” NBER Working Paper No. W7840 (August).
Christiano, Lawrence J., Christopher Gust, and Jorge Roldos. 2004. “Monetary Policy in a Financial Crisis.” Journal of Economic Theory 119 (1): 64–103.
Diamond, Douglas W., and Raghuram G. Rajan. 2001. “Liquidity Shortages and Financial Crises.” Mimeo, University of Chicago (June).
Diamond, Douglas W., and Raghuram G. Rajan. 2003. “Money in a Theory of Banking.” NBERWorking Paper No. 10070 (October).
Dooley, Michael. 1999. “Responses to Volatile Capital Flows: Controls, Asset-Liability Management and Architecture.” World Bank Conference on Capital Flows, Financial Crises, and Policies (April).
Dornbusch, Rudiger. 1976. “Expectations and Exchange Rate Dynamics.” Journal of Political Economy 84 (December).
Dornbusch, Rudiger. 2001. “Fewer Monies, Better Monies.” NBER Working Paper No. 8324 (June).
Eaton, Jonathan, and Mark Gersovitz. 1981. “Debt with Potential Repudiation: Theory and Estimation.” Review of Economic Studies 48:289–309.
Edwards, Sebastian, and Eduardo Levy-Yeyati. 2003. “Flexible Exchange Rates as Shock Absorbers.” NBER Working Paper No. 9867 (June).
Furman, Jason, and Joseph E. Stiglitz. 1998. “Economic Crises: Evidence and Insights from East Asia.” Brookings Papers of Economic Activity 2.
Gertler, Mark, Simon Gilchrist, and Fabio M. Natalucci. 2001. “External Constraints on Monetary Policy and the Financial Accelerator.” New York University Working Paper (February).
Hausmann, Ricardo, Ugo Panizza, and Ernesto Stein. 2001. ”Why do countries float the way they float?” Journal of Development Economics 66 (2): 387–414.
Holmstrom, Bengt, and Jean Tirole. 1998. “Private and Public Supply of Liquidity.” Journal of Political Economy 106 (1): 1–40.
Kiyotaki, Nobuhiro, and John Moore. 1997. “Credit Cycles.” Journal of Political Economy 105 (2): 211–48.
Lorenzoni, Guido. 2001. “Interest Rate Stabilization and Monetary Control: A Reconciliation.” Mimeo, Princeton University.
Woodford, Michael. 1990. “Public Debt as Private Liquidity.” American Economic Review, Papers and Proceedings 80 (May): 382–88.