The macroeconomics of carry trade gone wrong: Corporate and consumer losses in Emerging Europe

We analyze the macroeconomic consequences of foreign currency losses by banks, corporates and consumers. To that end, we construct a New Keynesian DSGE model with debt overhang for corporate borrowers, monitoring costs for household mortgage debt and leverage constraints for banks. The Hungarian experience at the end of 2008 and model estimation on Hungarian data motivate these particular financial frictions. Model simulation shows that making corporate borrowers bear currency risk results in worse macroeconomic outcomes than currency mismatch losses on bank balance sheets. Foreign currency mortgages to households, however, generate lower output losses than currency mismatch in the banking sector. The fact that households do not suffer from debt overhang contributes to this result.