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Financial Frictions and Real Devaluations

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Author Info
Alvaro Aguirre
César Calderón
Abstract

In this paper I study the effects of real exchange rate devaluations on output performance using a sample of large devaluation episodes for a group of emerging and developed countries. I find that balance sheet effects, captured by the interaction between the real exchange rate devaluation and the level of external indebtedness of the country, have a significant and negative impact on output. Nevertheless, there is also evidence of a positive effect of the real devaluation associated to the traditional expansionary effect. For countries with large foreign-denominated external debt, the combined effect of the real exchange rate depreciation is likely to generate significant output losses in the short-run. However, in the medium term, the expansionary effect of the real devaluation tends to dominate the balance sheet effect, which implies a positive effect on output in the medium term. Finally, countries with deeper financial market experience lower output losses following a devaluation.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 318.

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Date of creation: May 2005
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Handle: RePEc:chb:bcchwp:318

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