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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

Related research

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

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References

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Cited by:
  1. Christian Saborowski & Sarah Sanya & Hans Weisfeld & Juan Yepez, 2014. "Effectiveness of Capital Outflow Restrictions," IMF Working Papers 14/8, International Monetary Fund.

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