A Corporate Balance-Sheet Approach to Currency Crises

This paper presents a general equilibrium currency crisis model of the ’thirdgeneration’, in which the possibility of currency crises is driven by the in-terplay between private firms’ credit-constraints and nominal price rigidities.Despite our emphasis on microfoundations, the model remains sufficientlysimple that the policy analysis can be conducted graphically. The analysishinges on four main features i) ex post deviations from purchasing powerparity; ii) credit constraints a la Bernanke-Gertler; iii) foreign currency bor-rowing by domestic firms; iv) a competitive banking sector lending to firmsand holding reserves and a monetary policy conducted either through openmarket operations or short-term lending facilities. We derive sufficient con-ditions for the existence of a sunspot equilibrium with currency crises. Weshow that an interest rate increase intended to support the currency in acrisis may not be effective, but that a relaxation of short-term lending facil-ities can make this policy effective by attenuating the rise in interest ratesrelevant to firms.