External Constraints on Monetary Policy and the Financial Accelerator

Mark Gertler, Simon Gilchrist, Fabio Natalucci

NBER Working Paper No. 10128
Issued in December 2003
NBER Program(s):   EFG   IFM   ME

We develop a small open economy macroeconomic model where financial conditions influence aggregate behavior. We use this model to explore the connection between the exchange rate regime and financial distress. We show that fixed exchange rates exacerbate financial crises by tieing the hands of the monetary authorities. We then investigate the quantitative significance by first calibrating the model to Korean data and then showing that it does a reasonably good job of matching the Korean experience during its recent financial crisis. In particular, the model accounts well for the sharp increase in lending rates and the large drop in output, investment and productivity during the 1997-1998 episode. We then perform some counterfactual exercises to illustrate the quantitative significance of fixed versus floating rates both for macroeconomic performance and for welfare. Overall, these exercises imply that welfare losses following a financial crisis are significantly larger under fixed exchange rates relative to flexible exchange rates.

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Document Object Identifier (DOI): 10.3386/w10128


  • Gertler, Mark, Simon Gilchrist, and Fabio Natalucci. "External Constraints on Monetary Policy and the Financial Accelerator," Proceedings, Federal Reserve Bank of San Francisco, March 2-3, 2001 ,
  • Gertler, Mark, Simon Gilchrist, and Fabio Natalucci. "External Constraints on Monetary Policy and the Financial Accelerator," Journal of Money, Credit and Banking 39(2-3): 295-330, March/April 2007

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