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Debt Overhang and Real Exchange Rate Overshooting in the Asian Crisis

Author

Listed:
  • David Vines
  • Gordon Douglas Menzies
  • Economic Research Department
  • Reserve Bank of Australia.

Abstract

We develop a stylized real model of the Asian crisis where an adverse extenal shock can lead to real exchange rate overshooting. Domestic borrowers of foreign capital are bound by debt contracts even when the capital is unable to earn the world rate of return. Following an adverse shock, the requirement to honour these debt contracts leads to a debt overhang. In the long run, when capital becomes mobile, extra-marginal projects are shut down as capital departs, and the real exchange rate falls by more than the terms of trade shock. In the short run, the real exchange rate is partly determined by demand conditions by means of what we call the wage and overhang multipliers. For reasonable production and consumption parameters, the short run real exchange rate - driven by the wage and overhang multipliers - overshoots its long run value.

Suggested Citation

  • David Vines & Gordon Douglas Menzies & Economic Research Department & Reserve Bank of Australia., 2002. "Debt Overhang and Real Exchange Rate Overshooting in the Asian Crisis," Economics Series Working Papers 122, University of Oxford, Department of Economics.
    • Handle: RePEc:oxf:wpaper:122
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    References listed on IDEAS

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    1. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, April.
    2. Young, Alwyn, 1994. "Lessons from the East Asian NICS: A contrarian view," European Economic Review, Elsevier, vol. 38(3-4), pages 964-973, April.
    3. Feldman, David H., 1991. "Economic policy and the relative price of services in LDCs," World Development, Elsevier, vol. 19(10), pages 1381-1389, October.
    4. Paul Krugman, 1999. "Balance Sheets, the Transfer Problem, and Financial Crises," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 6(4), pages 459-472, November.
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    Cited by:

    1. Vines, David & Kirsanova, Tatiana & Menzies, Gordon, 2007. "Stiglitz Versus the IMF on the Asian Debt Crisis: An Intertemporal Model with Real Exchange Rate Overshooting," CEPR Discussion Papers 6318, C.E.P.R. Discussion Papers.

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    More about this item

    Keywords

    Asian crisis; exchange rate overshooting; mulitplier; overhang;
    All these keywords.

    JEL classification:

    • F11 - International Economics - - Trade - - - Neoclassical Models of Trade
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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