Exchange rate volatility and the credit channel in emerging markets
Subtitle: A vertical perspective
By: Ricardo Caballero, Arvind Krishnamurthy.
Contributors: Krishnamurthy, Arvind.; National Bureau of Economic Research.
Series: NBER working paper series ;; working paper 10517; Working paper series (National Bureau of Economic Research : Online) ;; working paper no. 10517.
Publisher: National Bureau of Economic Research
Published: 2004
Place of publication: Cambridge, MA
Language: eng
Format: Electronic resource
Subjects: Foreign exchange rates.; Credit.; Mixed economy.
Description: "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"--National Bureau of Economic Research web site.
Notes: Includes bibliographical references.
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