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Type: Journal article
Title: Real sector shocks and monetary policy responses in a financially vulnerable emerging economy
Author: Rajan, Ramkishen D.
Parulkar, Makarand
Citation: Emerging Markets Finance and trade, 2008; 44 (3):21-33
Publisher: M E Sharpe
Issue Date: 2008
ISSN: 1540-496X
School/Discipline: School of Economics
Abstract: When analyzing the appropriate response for monetary policy during a currency crisis, it is important to keep in mind two distinct channels: the effect of raising interest rates on exchange rates and the direct effect of exchange rate changes on output. The first pertains to the monetary side of the economy as given by the interest parity condition. The second pertains to the real side of the economy. The interaction between these two parts of the economy derives the equilibrium output and exchange rate in the economy. This paper expands on the Aghion et al. (2000) monetary model with nominal rigidities and foreign currency debt, to examine the interaction between the real and monetary sides of the economy and to analyze the effect of monetary policy on the real economy. We find that the effect of monetary policy on exchange rate and output is theoretically ambiguous. This in turn suggests that the appropriate monetary policy response could vary among countries at any point in time, or for a particular country between two different periods.
Keywords: balance sheet effects; currency crisis; exchange rate depreciation; Laffer curve effects; monetary policy
DOI: 10.2753/REE1540-496X440302
Appears in Collections:Economics publications

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