Exchange Rate Shocks, Financial Crisis and Output Loss
This chapter studied stylized facts and the basic mechanisms of exchange-rate caused financial and real crises. As we have shown it is likely to be the connection of weak balance sheets (of households, firms, financial intermediaries, governments and countries) and large exchange rate shocks that lead to positive feedback mechanisms and thus to credit contraction, declining asset prices and economic activity, real crisis and large output loss. This in particular appears to be a basic mechanism if there exists in the country large debt denominated in foreign currency. Moreover, as we have shown, credit rationing and state dependent default premia may entail destabilizing mechanisms, possibly leading to low level equilibria.147 The insight of how financial and real risk can be enlarged by large currency shocks and to what extent an international portfolio might be able to hedge this risk is studied further in Chap. 13.
KeywordsExchange Rate Interest Rate Balance Sheet Foreign Currency Credit Market
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