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External Constraints on Monetary Policy and the Financial Accelerator
Author(s) -
GERTLER MARK,
GILCHRIST SIMON,
NATALUCCI FABIO M.
Publication year - 2007
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/j.0022-2879.2007.00027.x
Subject(s) - financial accelerator , economics , counterfactual thinking , exchange rate , monetary policy , monetary economics , exchange rate regime , financial crisis , interest rate , productivity , tying , financial distress , financial market , investment (military) , small open economy , dynamic stochastic general equilibrium , finance , macroeconomics , financial system , philosophy , epistemology , politics , law , political science , microeconomics
We develop a small open economy macroeconomic model where financial conditions influence aggregate behavior. Our goal is to explore the connection between the exchange rate regime and financial distress. We first show that a calibrated version of the model captures well the behavior of the Korean economy during its financial crisis period of 1997–98. In particular, the model accounts for the sharp increase in lending rates and the large drop in output, employment, investment, and measured productivity. The financial market frictions play an important role, further, explaining roughly half the decline in overall economic activity. We then perform some counterfactual exercises to illustrate how the fixed exchange rate regime likely exacerbated the crisis by tying the hands of monetary policy.