TY  - JOUR
AU  - Burnside,Craig
AU  - Eichenbaum,Martin
AU  - Rebelo,Sergio
TI  - Hedging and Financial Fragility in Fixed Exchange Rate Regimes
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 7143
PY  - 1999
Y2  - May 1999
UR  - http://www.nber.org/papers/w7143
L1  - http://www.nber.org/papers/w7143.pdf
N1  - Author contact info:
Craig Burnside
Department of Economics
Duke University
213 Social Sciences Building
Durham, NC 27708-0097
Tel: 919/660-1808
Fax: 919/684-8974
E-Mail: craig.burnside@duke.edu

Martin S. Eichenbaum
Department of Economics
Northwestern University
2003 Sheridan Road
Evanston, IL  60208
Tel: 847/491-8232
Fax: 847/491-7001
E-Mail: eich@northwestern.edu

Sergio Rebelo
Northwestern University
Kellogg School of Management
Department of Finance
Leverone Hall
Evanston, IL  60208-2001
Tel: 847/467-2329
Fax: 847/491-5719
E-Mail: s-rebelo@northwestern.edu
AB  - Currency crises that coincide with banking crises tend to share four elements.  First, governments provide guarantees to domestic and foreign bank creditors.  Second, banks do not hedge their exchange rate risk.  Third, there is a lending boom before the crises.  Finally, when the currency/banking collapse occurs, interest rates rise and there is a persistent decline in output. This paper proposes an explanation for these regularities.  We show that government guarantees lower interest rates and generate an economic boom.  They also lead to a more fragile banking system; banks choose not to hedge exchange rate risk.  When the fixed exchange rate is abandoned in favor of a crawling peg, banks go bankrupt, the domestic interest rate rises, real wages fall, and output declines.
ER  -