Goodhart C.1, Isakov K.2, Peiris U.2, Tsomocos D.3
  • 1 London School of Economics and Financial Markets Group, Houghton Street, London, WC2A 2AE, United Kingdom
  • 2 National Research University Higher School of Economics, 20, Myasnitskaya st., Moscow, 101000, Russian Federation
  • 3 Saïd Business School and St Edmund Hall, University of Oxford, Park End Street, Oxford, OX1 1HP, United Kingdom

Debt Overhang and Monetary Policy in Czech Republic

2018. Т. 22. № 3. С. 460–479 [содержание номера]

We investigate the consequences of excessive international debt overhang asthey relate to both debtor and creditor countries. In particular, we assess the impact of monetary policy on financial stability and how it can be used to smooth borrowers, as well as creditors, consumption over the business cycle. Based on [Goodhart, Peiris, Tsomocos, 2018], we establish that an independent countercyclicalmonetary policy, that contracts liquidity whenever debt grows whereas it expands it when default rises, reduces volatilityof consumption.In effect,monetary policy provides an extra degree of freedom to the policymaker. We implement our approach to the Czech and Eurozone area economies during the 1990s.

In our model, we introduce endogenous defaultά la[Shubik, Wilson, 1977], whereby debtors incur a welfare cost in renegotiating their contractual debt obligations that is commensurate to the level of default. However, this cost depends explicitly on the business cycle and it should be countercyclical. Hence, contractionary monetary policy reduces the volume of trade and efficiency, thus increasingdefault. This occurs as the default cost increases the associated default acceleratorchannel engenders higher default rates. On the other hand, lower interest rates increase trade efficiency and, consequently, reduce the amplitude of the business cycle and benefit financial stability.

In sum, the appropriate design of monetary policy complements financial stability policy. The modelling of endogenous default allows us to study the interaction of monetary and macroprudential policy.
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