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Exchange rate regime and household's choice of debt

Vidakovic, Neven (2014): Exchange rate regime and household's choice of debt.

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Abstract

The paper looks at the impact of the exchange rate regime and the household’s choice of debt. One of the characteristics of economic transition in eastern European countries was an increase in overall debt holding. Standard economic theory assumes the relationship S=I. According to this relationship the households should use debt only for purchases of durable goods; however in some eastern European countries there was a large increase in consumer loans which are not recognized under standard no-ponzi assumption of economic models. This paper aims to investigate the case when debt is used to live above household’s budget constraint. Our model shows a significant impact on the choice of the amount the debt the households are willing to hold is due to the choice of the exchange rate regime made by the central bank. The models investigates household’s behavior in two main cases: stable exchange rate regime (exchange rate regime with FX risk) and variable exchange rate regime (exchange rate regime without exchange rate risk). The households make different choices under alternate exchange rate regime; this pattern of is behavior shown in the model and verified by the data.

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