Abstract
This paper studies the optimal monetary and macroprudential policies in a small open economy that borrows from abroad in foreign currency. The model features a novel mechanism in which sudden stops due to an occasionally binding borrowing constraint trigger a sharp currency depreciation through balance of payments adjustments, thereby increase the domestic-currency value of foreign debt and cause severe economic downturns. A policy analysis shows that a contractionary monetary policy mitigates depreciation during a crisis, but the anticipation of policy interventions during the crisis induces larger borrowings ex ante and destabilizes the economy. A combination of an ex ante macroprudential tax on foreign borrowing and ex post monetary policy interventions can stabilize the economy and improve social welfare.
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Disclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.