An Evaluation of the Contractionary Devaluation Hypothesis
AbstractRecent empirical and theoretical literature on the impact of real exchange rate devaluations on economic performance questions the traditional expansionary effect generated within standard Mundell-Fleming models. Contractionary devaluations may arise when firms face maturity or currency mismatches that, when faced with real exchange rate depreciations, lead to balance-sheet effects that erode firms` wealth and lead to an output contraction. While some authors show that the standard Mundell-Fleming result may hold even in the presence of currency mismatches, others point out that, if the balance sheet effect is large enough, devaluations can be contractionary. Using a large panel of 57 countries across the world and various newly constructed measures of dollarization, we test whether the balance sheet effect hypothesis has been relevant during the past decades in explaining economic downturns. Additionally, we explore the channels through which devaluations can be contractionary; in particular, we explore whether investment and consumption decisions are negatively affected by exchange rate devaluations under currency mismatches.
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Bibliographic InfoPaper provided by Inter-American Development Bank, Research Department in its series Research Department Publications with number 4486.
Date of creation: Jul 2006
Date of revision:
Other versions of this item:
- Ricardo N. Bebczuk & Ugo Panizza & Arturo Galindo, 2006. "An Evaluation of the Contractionary Devaluation Hypothesis," IDB Publications 6712, Inter-American Development Bank.
- Ricardo Bebczuk & Arturo Galindo & Ugo Panizza, 2006. "An Evaluation of the Contractionary Devaluation Hypothesis," Department of Economics, Working Papers 064, Departamento de Economía, Facultad de Ciencias Económicas, Universidad Nacional de La Plata.
- E0 - Macroeconomics and Monetary Economics - - General
- F0 - International Economics - - General
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
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