Limits of Floats: The Role of Foreign Currency Debt and Import Structure
AbstractA 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 a model with high foreign currency debt and low exchange rate pass through to import prices. 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 indebtedness 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 can even amplify the output response if foreign indebtedness is high.
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Bibliographic InfoPaper provided by Economics Section, The Graduate Institute of International Studies in its series IHEID Working Papers with number 01-2010.
Length: 38 pages
Date of creation: 10 Jan 2010
Date of revision: Jan 2010
Exchange Rate Regimes; Balance Sheet Effects; Pass-through; Interacted Panel VAR; External Shocks;
Find related papers by JEL classification:
- E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
- F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
- F34 - International Economics - - International Finance - - - International Lending and Debt Problems
- F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-10-23 (All new papers)
- NEP-CBA-2010-10-23 (Central Banking)
- NEP-MON-2010-10-23 (Monetary Economics)
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