Working Paper: CEPR ID: DP8938
Authors: Pierpaolo Benigno; Federica Romei
Abstract: 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.
Keywords: current account adjustment
JEL Codes: E40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| debt deleveraging (H63) | short-term currency depreciation (F31) |
| short-term currency depreciation (F31) | demand for foreign goods (F49) |
| debt deleveraging (H63) | long-term currency appreciation (F31) |
| long-term currency appreciation (F31) | higher demand for domestic goods (R22) |
| debt deleveraging (H63) | real interest rate falls (E43) |
| real interest rate falls (E43) | stimulate consumption by creditors (E62) |