Working Paper: CEPR ID: DP5905
Authors: Marcus Miller; Javier Garcia-Fontini; Lei Zhang
Abstract: 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.
Keywords: contractionary devaluation; financial crises; Keynesian recession; supply and demand shocks
JEL Codes: E12; E4; E51; F34; G18
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| devaluation (F31) | decreased output (P44) |
| liability dollarization (F65) | decreased output (P44) |
| devaluation (F31) | decline in investment (E22) |
| decline in investment (E22) | decreased output (P44) |
| supply shocks + demand contractions (E39) | more severe economic downturns (F44) |
| initial fall in output (E23) | temporary demand effect (J23) |
| subsequent downshift in potential output (E23) | persistent supply-side issue (P42) |