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Liability dollarization and the bank channel

Authors Choi, Woon Gyu
Cook, David E.
Issue Date 2002-03
Summary Banks in developing economies often face a mismatch in the currency denomination of their liabilities (foreign currency denominated debt incurred from foreign lenders) and assets (domestic currency loans to domestic borrowers). We study the effect of this mismatch on business cycles and monetary policy in a sticky price, dynamic general equilibrium model of a dependent economy. We show that a fixed exchange rate rule that stabilizes the balance sheets of banks offers greater stability to a developing economy than would an inflation targeting interest rate rule. This result differs sharply from standard macroeconomic intuition which suggests that inflation targeting ameliorates the destabilizing effects of sticky prices.
Language English
Format Working paper
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