Overshootings and Reversals: The Role of Monetary Policy
In: Banking, Financial Integration, and International Crises
AbstractThis paper provides evidence on the relationship between monetary policy and the exchange rate in the aftermath of currency crises taking into account the role of a fragile banking system. It analyzes a large set of currency crises that led to real exchange rate undervaluations from a sample of 80 countries in the period 1980 to 1998. First, the paper evaluates whether tight monetary policy increases substantially the probability of reversing the undervaluation through nominal appreciation of the exchange rate rather than through higher inflation. Second, using panel data, the paper estimates the relationship between real exchange rates and real interest rates. We find that tight monetary policy facilitates the reversal of the real exchange rate through nominal appreciation rather than inflation. In contrast, when the economy is also facing a banking crisis, tight monetary policy may not have the same effect.
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This chapter was published in: Leonardo Hernández & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series Editor) (ed.) Banking, Financial Integration, and International Crises, , chapter 9, pages 279-302, 2002.
This item is provided by Central Bank of Chile in its series Central Banking, Analysis, and Economic Policies Book Series with number v03c09pp279-302.
Other versions of this item:
- Ilan Goldfajn & Poonam Gupta, 2001. "Overshootings and Reversals: The Role of Monetary Policy," Working Papers Central Bank of Chile 126, Central Bank of Chile.
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- Kenneth Rogoff, 1992. "Traded Goods Consumption Smoothing and the Random Walk Behavior of the Real Exchange Rate," NBER Working Papers 4119, National Bureau of Economic Research, Inc.
- Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
- Allan Drazen & Paul R. Masson, 1993.
"Credibility of Policies versus Credibility of Policymakers,"
NBER Working Papers
4448, National Bureau of Economic Research, Inc.
- Drazen, Allan & Masson, Paul R, 1994. "Credibility of Policies versus Credibility of Policymakers," The Quarterly Journal of Economics, MIT Press, vol. 109(3), pages 735-54, August.
- Paul R. Masson & Allan Drazen, 1994. "Credibility of Policies Versus Credibility of Policymakers," IMF Working Papers 94/49, International Monetary Fund.
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