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Limits of floating exchange rates: The role of foreign currency debt and import structure

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  • Towbin, Pascal
  • Weber, Sebastian

Abstract

A traditional argument in favor of flexible exchange rates is that they insulate output better from real shocks, because the exchange rate can adjust and stabilize demand for domestic goods through expenditure switching. This argument is weakened in models with high foreign currency debt and low exchange rate pass-through to import prices. The present study evaluates the empirical relevance of these two factors. We analyze the transmission of real external shocks to the domestic economy under fixed and flexible exchange rate regimes for a broad sample of countries in a Panel VAR and let the responses vary with foreign currency debt and import structure. We find that flexible exchange rates do not insulate output better from external shocks if the country imports mainly low pass-through goods and foreign indebtedness is high.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Development Economics.

Volume (Year): 101 (2013)
Issue (Month): C ()
Pages: 179-194

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Handle: RePEc:eee:deveco:v:101:y:2013:i:c:p:179-194

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Web page: http://www.elsevier.com/locate/devec

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Keywords: Exchange rate regimes; Balance sheet effects; Pass-through; Interacted panel VAR; External shocks;

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Cited by:
  1. Tomasz Wieladek & Sergi Lanau, 2012. "Financial Regulation and the Current Account," IMF Working Papers 12/98, International Monetary Fund.
  2. Georgiadis, Georgios, 2012. "The panel conditionally homogenous vectorautoregressive model," MPRA Paper 37755, University Library of Munich, Germany.
  3. Glocker, C. & Towbin, P., 2012. "Reserve Requirements for Price and Financial Stability - When Are They Effective?," Working papers 363, Banque de France.
  4. Sergio Sola, 2013. "Temporary and Persistent Fiscal Policy Shocks," IHEID Working Papers 06-2013, Economics Section, The Graduate Institute of International Studies.
  5. Christian Saborowski & Sebastian Weber, 2013. "Assessing the Determinants of Interest Rate Transmission Through Conditional Impulse Response Functions," IMF Working Papers 13/23, International Monetary Fund.
  6. Georgiadis, Georgios, 2014. "Towards an explanation of cross-country asymmetries in monetary transmission," Journal of Macroeconomics, Elsevier, vol. 39(PA), pages 66-84.
  7. Nickel, Christiane & Tudyka, Andreas, 2013. "Fiscal stimulus in times of high debt: reconsidering multipliers and twin deficits," Working Paper Series 1513, European Central Bank.

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