What is it about?
This paper constructs a twin banking and currency crisis model by introducing the banking sector into the currency crisis model and examining the case in which the exchange rate risk is located in the banking system. The model shows that an unanticipated shock caused by the shift of investors’ expectations and/or a negative productivity shock can trigger a twin banking and currency crisis.
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Why is it important?
To achieve both financial stability and economic stability, the central bank should lower the policy interest rate and the reserve requirement ratio and raise the interest rate on reserves.
Perspectives
The location of the exchange rate risk matters for the choice of an appropriate monetary policy response during a crisis. When the exchange rate risk is located in the banking sector, the conventional policy recommendation in response to a currency crisis – interest rate hike – is not appropriate.
Dr. Ryota Nakatani
International Monetary Fund
Read the Original
This page is a summary of: Twin Banking and Currency Crises and Monetary Policy, Open Economies Review, February 2016, Springer Science + Business Media,
DOI: 10.1007/s11079-016-9391-2.
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