پشت صحنه هایی از رها کردن یک رژیم نرخ ارز ثابت

This paper explores the process of abandoning a fixed exchange rate regime during sudden stops in a small open economy. The Bank of Korea’s exchange rate policy reports during the East Asian crisis suggest that its fixed exchange rate regime was forced to collapse due to the depletion of usable foreign reserves, which resulted from the credit policy of the Korean central bank to support domestic banks in need of foreign currency liquidity. To capture the Korean crisis experience, I build a quantitative small open economy model in which, in response to the country risk premium shock, the foreign-currency credit policy of a central bank under fixed regime leads to the exhaustion of international reserves and consequent exchange rate regime shift. This model does well at replicating the observed contraction in Korean aggregate variables.

Much of the literature that studies the quantitative feature of sudden stops in emerging economies introduces different kinds of financial constraints and tries to generate business cycle patterns similar to those in real aggregate data. While this strand of literature mostly focuses on the sovereign defaults widely observed in the sudden stops of Latin American countries, the notably common but often understudied feature is a collapsing exchange rate regime. Economic theory offers little policy guidance on the exchange rate regime shift, but there exist the two opposing views on this issue. The conventional one in the spirit of Krugman, 1979 and Flood and Garber, 1984 is that the fixed exchange rate is abandoned only if the central bank exhausts its foreign exchange reserves. The recent papers, however, argue that the central bank chooses to exit from the fixed regime as opposed being forced to do. For example, Rebelo and Végh (2008) provide the empirical evidence on this optimizing view. From the official international reserves data, they find out how many reserve assets have been consumed until the collapse of exchange rate regime. In roughly 75% of currency crises episodes from 1970 to 1997 except the East Asian crisis, the reserve losses during the 12 months prior to the crisis were less than 40%. As “the peg was abandoned with plenty of ammunition left in the central bank’s coffers” (Rebelo and Végh, 2008, p. 930), this evidence can be interpreted to support that the exit from the fixed regime is the result of optimal choice by the central bankers. If we consider the East Asian countries as well, South Korea, Thailand and Indonesia were not an exception. As pointed out by Fig. 1, they consumed less than 40% of initial reserve assets at the point of abandonment.1In this paper, my contribution is twofold. From the Bank of Korea’s internal policy reports during the currency crisis in 1997, I find out what really happened in the process of regime shift and whether the Korean central bank optimally chose to abandon or were involuntarily forced to do so. Second, I suggest a quantitative small open economy model to incorporate those findings from the Korean policy papers and replicate the Korean crisis experience. The Bank of Korea’s internal papers reveal the following two facts about the decision-making process during the exchange rate regime shift. First, as stressed by earlier literature on the Korean crisis such as Moon, 2000 and Park, 1998, the Korean policy reports confirm that there existed a discrepancy between publicly announced official foreign reserves and foreign reserves usable in defending the Korean won. When Korean commercial banks experienced the credit crunch as a reduction in foreign currency liquidity and the transaction in the foreign exchange market was significantly impeded due to strong expectation on the depreciation of the Korean currency, the Bank of Korea conducted the credit policy to save the banks from insolvency. The Bank of Korea deposited foreign currency in the foreign affiliates of financially distressed domestic banks. While these deposits were included in the official foreign reserves, they were not available for use in the crisis. Second, the fixed exchange rate regime was forced to collapse. At the point of abandonment, the Korean central bank expected usable foreign reserves to be completely depleted in the near future due to the continued demand from domestic banking sector, which could hardly finance their foreign debt. Based on these findings, the goal of the suggested model in this paper is to capture the foreign-currency credit policy during sudden stops in a small open economy. The model builds on Gertler, Gilchrist and Natalucci (2007) (hereafter, “GGN”) which considers the small open economy with financial frictions originally formulated by Bernanke, Gertler and Gilchrist (1999) (hereafter, “BGG”). This paper extends GGN into incorporating the credit policy following Gertler and Karadi, 2011 and Gertler and Kiyotaki, 2010 into an open economy setting. The central bank is assumed to deposit foreign currency at domestic commercial banks in response to the country risk premium. If international reserves are expected to be depleted as a result of the credit policy, the central bank is forced to switch to a floating regime with inflation targeting. This model does well at capturing the regime switching in the Korean crisis and the observed contraction in aggregate variables in response to the adverse country risk premium shock. In addition, a counterfactual experiment is provided to compare the impulse response of maintaining the fixed exchange rate regime by conservative credit policy with that of benchmark. The result suggests that even though the regime switching was unwanted, it actually brought better outcomes. This paper is naturally related to the literature that studies the effects of sudden stops on economic activity in emerging economies. Martins and Salles (2010) also study the credit policy in a small open economy, but the primary goal of their paper is to analyze the welfare effects of the credit policies by the Brazilian central bank during the recent financial crisis, while this paper focuses on exchange rate regime switching. As also shown in this paper, Céspedes et al., 2004 and Devereux et al., 2006 highlight the superiority of floating exchange rate regime for emerging economies in response to the negative world interest rate shock. Neumeyer and Perri, 2005 and Uribe and Yue, 2006 provide an empirical analysis on the effect of change in country risk premium on the business cycles of emerging economies. In addition, there exist few preceding studies that use the policy papers of the Bank of Korea during the crisis as in this paper. For example, Moon (2000) focuses on identifying the mistakes in a broad range of government policy including foreign exchange policy, financial policy and labor market policy, and points out rigid exchange rate policy as one of the policy mistakes. The rest of this paper is organized as follows. In the next section, I consider the findings from the Bank of Korea’s internal papers on the exchange rate policy during the East Asian crisis. In Section 3, I present a quantitative small open economy model with the foreign-currency credit policy of a central bank. In Section 4, parameter values will be selected. I also suggest the aggregate response when the model economy is hit by the country risk premium shock. I conclude this paper in Section 5.

In this paper, I study the process of exchange rate regime shifts during sudden stops in a small open economy, using the policy papers by the Bank of Korea to suggest the actual decision-making process within a central bank. Despite the recently popular modeling assumption that a central bank optimally chooses to abandon the fixed regime, the Bank of Korea’s case suggests that the conventional exit rule - the regime is abandoned if the reserve assets are exhausted, is more descriptive and that the official foreign reserves during sudden stops in emerging economies may be overestimated, due to the lack of transparency. I also develop a small open economy model with the credit policy of a central bank to support domestic banks in need of foreign currency liquidity. In the model, a crisis begins with a large shock to the country risk premium under the fixed exchange rate regime. If foreign reserve assets are expected to be depleted as a result of the credit policy, the central bank is forced to switch to the floating exchange rate regime before reserve assets are exhausted. This model does well at capturing the regime switching in the Korean crisis and the observed drop in aggregate variables.