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The contributions of domestic and external factors to Latin American devaluation crises: an early warning systems approach

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  • Steven B. Kamin
  • Oliver D. Babson
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    Abstract

    In this paper we develop a modified "early warning system" (EWS) approach to identifying the roles of domestic and external factors in Latin America's crises. Several probit models of balance-of-payments crises, based on different identified sets of crisis dates, were estimated for six Latin American countries. These models were then used to identify the separate contributions to the probabilities of crisis of domestic and external variables. Our basic finding is that, when the effect of adverse external shocks is removed from the simulated probabilities of devaluation in Latin America, the resultant simulated devaluation probabilities are still high. Taken at face value, these results indicate that devaluation crises in Latin America primarily have been a function of domestic policy and economic imbalances, with exogenous external factors playing only a secondary role. All else equal, this suggests that the adoption of strongly fixed exchange rate regimes in the region may not be too costly in terms of diminished ability to respond to exogenous external shocks.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 645.

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    Date of creation: 1999
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    Handle: RePEc:fip:fedgif:645

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    Keywords: Financial crises ; Latin America;

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    References

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    1. Hali J. Edison, 2000. "Do indicators of financial crises work? an evaluation of an early warning system," International Finance Discussion Papers 675, Board of Governors of the Federal Reserve System (U.S.).
    2. Joseph Joyce & Linda Kamas, 1997. "The relative importance of foreign and domestic shocks to output and prices in Mexico and Colombia," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 133(3), pages 458-478, September.
    3. John H. Rogers & Ping Wang, 1993. "Output, inflation, and stabilization in a small open economy: evidence from Mexico," Research Paper 9315, Federal Reserve Bank of Dallas.
    4. Graciela L. Kaminsky & Carmen M. Reinhart, 1996. "The twin crises: the causes of banking and balance-of-payments problems," International Finance Discussion Papers 544, Board of Governors of the Federal Reserve System (U.S.).
    5. Frankel, Jeffrey A. & Rose, Andrew K., 1996. "Currency crashes in emerging markets: An empirical treatment," Journal of International Economics, Elsevier, vol. 41(3-4), pages 351-366, November.
    6. Andrew Berg & Catherine Pattillo, 1999. "Are Currency Crises Predictable? A Test," IMF Staff Papers, Palgrave Macmillan, vol. 46(2), pages 1.
    7. Ricardo Hausmann & Michael Gavin & Carmen Pagés-Serra & Ernesto H. Stein, 1999. "Financial Turmoil and the Choice of Exchange Rate Regime," IDB Publications 4128, Inter-American Development Bank.
    8. Graciela Kaminsky & Saul Lizondo & Carmen M. Reinhart, 1998. "Leading Indicators of Currency Crises," IMF Staff Papers, Palgrave Macmillan, vol. 45(1), pages 1-48, March.
    9. Reuven Glick & Ramon Moreno, 1999. "Money and credit, competitiveness, and currency crises in Asia and Latin America," Pacific Basin Working Paper Series 99-01, Federal Reserve Bank of San Francisco.
    10. Alexander W. Hoffmaister & Jorge Roldos, 1997. "Are Business Cycles Different in Asia and Latin America?," IMF Working Papers 97/9, International Monetary Fund.
    11. Ricardo Hausmann & Michael Gavin & Carmen Pagés-Serra & Ernesto H. Stein, 1999. "Financial Turmoil and Choice of Exchange Rate Regime," Research Department Publications 4170, Inter-American Development Bank, Research Department.
    12. Catherine A. Pattillo & Andrew Berg & Gian-Maria Milesi-Ferretti & Eduardo Borensztein, 2000. "Anticipating Balance of Payments Crises," IMF Occasional Papers 186, International Monetary Fund.
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    Cited by:
    1. Shen, Chung-Hua & Chen, Chien-Fu, 2008. "Causality between banking and currency fragilities: A dynamic panel model," Global Finance Journal, Elsevier, vol. 19(2), pages 85-101.
    2. Fratzscher, Marcel & Matthieu Bussiere, 2003. "Towards A New Early Warning System of Financial Crises," Royal Economic Society Annual Conference 2003 81, Royal Economic Society.
    3. Hali J. Edison, 2003. "Do indicators of financial crises work? An evaluation of an early warning system," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 8(1), pages 11-53.
    4. Matthieu Bussi�re, 2013. "Balance of payment crises in emerging markets: how early were the ‘early’ warning signals?," Applied Economics, Taylor & Francis Journals, vol. 45(12), pages 1601-1623, April.
    5. Kemme, David M. & Roy, Saktinil, 2006. "Real exchange rate misalignment: Prelude to crisis?," Economic Systems, Elsevier, vol. 30(3), pages 207-230, October.
    6. Shaghil Ahmed, 1999. "Sources of economic fluctuations in Latin America and implications for choice of exchange rate regimes," International Finance Discussion Papers 656, Board of Governors of the Federal Reserve System (U.S.).
    7. Steven B. Kamin & John W. Schindler & Shawna L. Samuel, 2001. "The contribution of domestic and external factors to emerging market devaluation crises: an early warning systems approach," International Finance Discussion Papers 711, Board of Governors of the Federal Reserve System (U.S.).

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