Research Discussion Paper – RDP 2002-08 Currency Crises and Macroeconomic Performance

This paper presents some theory and evidence on the implications of sudden currency depreciations for output and inflation. It identifies some of the characteristics shared by countries which have suffered falling output in the aftermath of a currency crisis, and it presents a small model which rationalises aspects of this common experience. The model is then used to derive the optimal monetary policy response to a crisis. A key result is that a currency crisis which coincides with a banking crisis is more likely to depress output and may call for an accommodating monetary policy.

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