The views in this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of any other person associated with the Federal Reserve System. We thank Philippe Bacchetta, Ricardo Caballero, V.V. Chari, Patrick Kehoe, and Philip Lowe, as well as participants at the BIS conference on “Monetary stability, financial stability, and the business cycle.”
External Constraints on Monetary Policy and the Financial Accelerator
Article first published online: 18 APR 2007
Journal of Money, Credit and Banking
Volume 39, Issue 2-3, pages 295–330, March–April 2007
How to Cite
GERTLER, M., GILCHRIST, S. and NATALUCCI, F. M. (2007), External Constraints on Monetary Policy and the Financial Accelerator. Journal of Money, Credit and Banking, 39: 295–330. doi: 10.1111/j.0022-2879.2007.00027.x
- Issue published online: 18 APR 2007
- Article first published online: 18 APR 2007
- Received June 14, 2004; and accepted in revised form December 30, 2005.
- financial crises;
- exchange rate policy
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.