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Supply Shocks and Currency Crises: The Policy Dilemma Reconsidered

Marcus Miller, Javier García-Fronti and Lei Zhang

CSGR Working Paper 213/06

 

October 2006

 

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:  

Supply and demand shocks, financial crises, contractionary devaluation, Keynesian recession.

 

 

Contact Details:

 

Centre for the Study of Globalisation and Regionalisation

The University of Warwick

Coventry CV4 7AL

United Kingdom

 

marcus.miller@warwick.ac.uk