بحران ارز و سیاست پولی: مطالعه اقتصادهای پیشرفته و نوظهور

The studies regarding the appropriate monetary policy response in defending the domestic currency following a currency crisis do not gather around a robust answer. This study tries to emphasize the notion that there is no single policy applicable for all currency crises happened and happening in the global world. The approach of the study is presenting empirical evidence by focusing separately on the advanced and emerging economies and proving that the monetary policy response for the emerging economies should be different from the advanced economies, depending mainly on the vulnerabilities of these economies preceding and during the crisis periods. The study includes twenty four economies, in which fifteen of them are emerging and nine of them are advanced, for the crisis periods between 1986 and 2009. The main finding of the study is that the tight monetary policy is effective in the advanced economies, and detrimental in the emerging economies faced financial turbulence. The monetary policy has no significance in recent crisis episodes both for advanced and emerging economies. Advanced economies besides having more independent central banking, lower country riskiness and almost no default history; mainly have second generation model weaknesses which cause the increased interest rates to be successful in stabilizing the exchange rates. For the emerging economies the third generation model weaknesses play a major role together with the first generation model vulnerabilities. Thus the major policy implication follows that the policy makers should take into account the economic fragilities during the crisis in implementing the monetary policy.

Currency crisis which can be defined as “an episode in which the exchange rate depreciates substantially during a short period of time” (Burnside et al., 2008:1) never loses its popularity in the academic research. The recent global crisis brings the argument if the economic literature needs a new group of models for the crisis explanation. On the other hand, the monetary policy response to the currency crisis nevertheless attracts less attention in the literature. The accurate policy response to the crisis can stimulate rapid recovery of the economy. However, with the inaccurate policy, the economy can struggle with the crisis for years. Therefore following a crisis, implementing the appropriate monetary policy for the economic recovery is the crucial goal for the policy makers. The currency crisis literature gathers around three major theoretical models. First generation models, introduced by Krugman (1979) stem from the crises in Latin America in the seventies and eighties. These models focus on the policy inconsistency between holding the pegged exchange rate regime and monetary financing of government deficits in terms of either borrowing or exhausting the reserves. The crisis is predictable in these models; fundamental factors, such as a fall in the foreign exchange reserves below critical level, signal the crisis. The second generation models arose following the European Monetary System crisis. First developed by Obstfeld (1994), in these models the government faces a trade off between the goal of fixed exchange rate and other policy goals, as output growth, unemployment and inflation. The market players’ anticipation of the depreciation of currency can be self-fulfilling since the expectations increase the costs of defending the currency for the policy makers, consequently leading to the abandoning of the fixed exchange rate regime. In these models crises are not predictable and can occur even if no obvious trends in the fundamentals are observed. Third generation models, following the Asian crisis in the late 1990s, put forward the close connection between the fragilities in the balance sheets of private sector, and banking system and the currency crises. Various types of third generation models exist. Moral hazard problem, studied by Corsetti et al. (1998) focuses on the over investment caused by the hidden guarantees of the government. Another variety of models are introduced first by Krugman (1999) with the focus on the vulnerabilities of corporate balance sheets. The study on this field by Eijffinger and Goderis (2007) suggests that the decision of abandoning the fixed exchange rate regime depends on the pressure of the movements in the interest rates and the exchange rates on the fragilities of the corporate sector balance sheets. Lastly, some models focus on the fragile financial system. Chang and Velasco (1999) emphasize that in an economy with fixed exchange rates the bank failures caused by the international illiquidity of the domestic financial sector can lead to currency crisis. The likeliness of the crisis is higher in the liberalized financial system with banks having currency and maturity mismatches. The diverse nature of the currency crises complicates the monetary policy response in defending the exchange rates. “Conventional wisdom” explains the behavior of the exchange rates with a stable money demand function with various interest parity conditions for relating the expected returns from foreign and domestic financial assets. According to these models tighter monetary policy followed today, leads to a stronger currency today. However, the critics have argued that mainly, during crisis, the fall of the investors’ confidence to the economy decreases the attractiveness of the market. Although interest rates are high enough to cover the probability of default, since the increase is temporary; the expected future return is lower. If combined with the adversely affected economy, the expectation of lower return in the future leads to a depreciation of the expected future exchange rate which consequently weakens today’s currency. These opposing views have motivated various empirical studies. However, the studies point to different conclusions on the effectiveness of the monetary policy in defending the currency. The study conducted by Kraay (2003) indicates that there is little evidence that monetary policy has any positive or negative effect on the exchange rate. Another study carried out by Eijffinger and Goderis (2008) points out that the increased interest rates depreciate the currency in the aftermath of a currency crisis. Inspired from the conflicting findings, this study does a separate analysis on the interest rate response on exchange rates following a currency crisis for the emerging and advanced economies. The paper tries to prove that the monetary policy responses should be different depending on the causes of the crisis and the vulnerabilities of the economies. An empirical analysis is performed, following the methodology of the recent empirical article by Eijffinger and Goderis (2008), on 24 economies – 15 emerging, and 9 advanced – for the crisis periods between the years 1986 and 2009. The effect of the tight monetary policy on the domestic currency (nominal and real exchange rates) during currency crisis is investigated by including major indicators of the crises literature: deviation of the GDP growth, current account position, overvalued real exchange rates, domestic corporate short-term obligations, institutional quality of the country, foreign currency denominated short-term obligations, changes in the stock prices, fiscal position, capital account openness and the occurrence of banking crisis. On top of these variables a new country specific variable, transparency of central banking is included. The variable indicates “the extent to which central banks disclose information that is related to the policy making process”1 which is expected to influence the effectiveness of monetary policy in the aftermath of a crisis. In order to distinguish the non-linear effects of the monetary policy on the exchange rates for different levels of indicators, the interaction terms of these indicators with the monetary policy are included. Additionally, the non-linear effects of the quality variables, central bank transparency and institutional quality, are investigated by including the interaction of these variables with balance sheet variables and with each other. The results of the study provide insights for the policy makers concerning policy implementation following a crisis. The rest of the paper is as follows; Section 2 presents the data and methodology of the analysis, Section 3 presents the results of the estimations for the emerging and advanced economies with a further focus on the recent global crisis periods, Section 4 presents the results of the system GMM estimation and Section 5 concludes.

This paper has studied the effectiveness of the monetary policy following a currency crisis. In this context, the underlying causes of the crises have been studied and the effectiveness of the monetary policy response according to the various economic vulnerabilities is addressed. The paper contributes to the literature by conducting separate analysis on the emerging and advanced economies with pointing out the disparities of the economic weaknesses between two groups of economies and by introducing central bank transparency in to currency crisis analysis. The study concludes that for the advanced economies except the 2008 financial crisis episodes where monetary policy is implemented in response to financial instability, tight monetary policy is effective on exchange rate stabilization. However, for the emerging economies the monetary policy does not have a robust effect on the exchange rates.14 If the crisis accompanied by financial sector problems, tight monetary policy has detrimental effects on the domestic currency of these economies. In general, for both emerging and advanced economies, the current account deficits, appreciated real exchange rates and the country riskiness invite the currency crisis possibility. Emerging economies suffer from high short-term external debt levels, burst in the stock prices, low central bank transparency and banking crisis prior to currency crisis. In the aftermath of the crisis, for the emerging economies the monetary policy negatively influences the exchange rates if the private sector suffers from high domestic short-term debt, the financial markets are liberalized, government engages in elevated deficit levels, the foreign short-term debt compared to reserves is low, stock market prices crash and the monetary policy has lower transparency. For the advanced economies; however, other than current account deficits, overvalued real exchange rates and country riskiness, another major cause of the crisis is the slowdown in the GDP growth rate, an indicator of the second generation crisis models. The tight monetary policy in these economies is more effective if the economies do not suffer from current account deficits, collapsed stock prices and fiscal deficits. The analyses enlighten the unclear results regarding the empirical research on this area by underlining that the tight monetary policy’s ineffectiveness in exchange rate stabilization is an emerging economy problem and that the transparency of central banking and the influence of the increased interest rates on the indebtedness of the private sector of the country are important determinants of the effectiveness of the monetary policy. In that sense, the analyses in this study support the recent theoretical considerations regarding the contrarian view of the interest rate response on the exchange rates. In the recent crisis episodes the estimation results show no significant influence of monetary policy. Although most of the currencies weakened sharply, the recoveries were also quick since most of the economies have floating exchange rate regimes which make the implementation of the monetary policy much easier. As in the previous crisis periods, the real exchange rate appreciation is still a problem for these episodes in signaling crisis. Although the debt levels are high and balance sheets are weakened following the crisis, the non-financial corporate sector is more resilient to shocks compared to 1990s. The successful restructuring of this sector plays a major part in decreasing the default probability in emerging economies. The study also uncovers the influence of balance sheet factors on the exchange rates and the results do not go along with the previous literature. It is well cited in the literature that currency and maturity mismatches which is also called “original sin”15 cause the reversal of capital flows and consequently to crisis in fragile economies. Therefore in the presence of these fragilities, it is expected that tight policy would increase the depreciation of the exchange rates. However, contradicting with the previous literature, monetary policy appears to be more effective in episodes with high foreign currency denominated short-term debt. High external debt increases the dedication of the monetary authorities in exchange rate stabilization and it makes the policy implementation easier.16 The high institutional quality with devalued currency attracts the capital into the economy and helps the stabilization of the exchange rates. On the other hand, high domestic short-term debt makes the tight monetary policy implementation ineffective since high interest rates increase the default probability of the corporate sector. Therefore in the episodes with high levels of private debt interest rate increase leads to further capital outflow and depreciation of the domestic currency. The main policy implication following the results is that one recipe does not work for all patients: a boost in the interest rates does not promise recovery for every crashed currency and economy. The economic vulnerabilities should be taken into account in designing the monetary policy. If the third generation indicators cause the crisis, the monetary policy should aim at financial sector stabilization. The expansionary monetary policy strengthens the corporate and financial sectors’ balance sheets and accelerates the economic recovery. In emerging economies the perception of foreigners regarding the economy and exchange rate market is crucial in stabilizing the domestic currency. Especially high country risk jeopardizes the financing of the debts of the financial system and the corporate sector. Therefore easy reach to the external funding is crucial. In preventing third generation type crises, stronger financial institutions and a gradual liberalization of the financial system are vital. Flexible exchange rate management is essential for successful monetary policy implementation. The composition of the short-term debt is another essential point in responding the currency crisis. In the presence of external debt, the tight monetary policy signals devotion of central bank in defending crisis. However, since increased interest rates leads to higher debt levels for the private sector, the expansionary monetary policy should be implemented if the firms are highly leveraged. In most of the first and second generation crises, if a strong financial system and private sector exist, tightening the monetary policy is successful in balancing the exchange rates. In preventing the first generation crises, focusing on a tighter fiscal policy, running a balanced budget is a preferred strategy. Although in the short run this policy suppresses economic activity, in the long run it does not impair growth potential of the output. As for the second generation crisis, the prevention of the crisis can be through reliable policies to prevent the currency from the attack of the speculators. In these types of crises, the market players’ perception of the domestic polices is much more crucial then the policy makers’ intentions. Thus even the policy implemented by the central bank is the correct policy, speculative attack can still occur. Although the various fragilities require different approaches in dealing with the crisis, the first and main goal of the policy maker is maintaining the trust to the economy