Does Monetary Policy Stabilize the Exchange Rate Following a Currency Crisis?

Abstract

This paper provides evidence on the relationship between monetary policy and the exchange rate in the aftermath of currency crises. It analyzes a large dataset of currency crises in 80 countries for the period 1980-98. The main question addressed is whether monetary policy can increase the probability of reversing a postcrisis undervaluation through nominal appreciation rather than higher inflation. We find that tight monetary policy facilitates the reversal of currency undervaluation through nominal appreciation. When the economy also faces a banking crisis, the results are not robust and depend on the specification.