• Exchange rates and currency crises

Exchange rates and currency crises

This paper examines the effects of world interest rate shocks on real activity in Thailand. The analysis incorporates balance sheet related credit market frictions into the IMF’s Global Economy Model (GEM) and finds that Thailand would best minimize the adverse effects of rising world interest rates if it were to follow a flexible exchange rate regime.

The paper finds that in the presence of the financial accelerator, foreign interest rate shocks lead to more severe recessions because of underlying balance sheet vulnerabilities. The paper studies how the Thai monetary authorities may best respond to foreign interest rate shocks. The results indicate that the fully flexible exchange rate regime stabilizes real macroeconomic variables the best. The depreciation of the exchange rate creates expenditure-switching effects that dominate the balance sheet effects. The main policy implication of the paper is that the best monetary policy option for the Thai authorities would be to pursue a flexible exchange rate regime to better handle the challenges of an external environment characterized by rising global interest rates.

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