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Automatic Stabilizer Feature of Fixed Exchange Rate Regimes in Emerging Markets

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Author Info
Uluc Aysun (University of Connecticut)

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Abstract

This paper shows that countries characterized by a financial accelerator mechanism may reverse the usual finding of the literature -- flexible exchange rate regimes do a worse job of insulating open economies from external shocks. I obtain this result with a calibrated small open economy model that endogenizes foreign interest rates by linking them to the banking sector.s foreign currency leverage. This relationship renders exchange rate policy more important compared to the usual exogeneity assumption. I find empirical support for this prediction using the Local Projections method. Finally, 2nd order approximation to the model finds larger welfare losses under flexible regimes.

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File URL: http://www.econ.uconn.edu/working/2006-27.pdf
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Publisher Info
Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2006-27.

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Length: 33 pages
Date of creation: Aug 2006
Date of revision:
Handle: RePEc:uct:uconnp:2006-27

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Related research
Keywords: accelerator balance sheets welfare EMBI

Find related papers by JEL classification:
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
F31 - International Economics - - International Finance - - - Foreign Exchange
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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  1. Roberto Chang & Andres Velasco, 1998. "Financial crises in emerging markets: a canonical model," Working Paper 98-10, Federal Reserve Bank of Atlanta. [Downloadable!]
  2. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier. [Downloadable!] (restricted)
    Other versions:
  3. Chang, R. & Velasco, A., 1998. "Financial Crises in Emerging Markets: A Canonical Model," Working Papers 98-21, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
  4. Mark Gertler & Simon Gilchrist & Fabio Natalucci, 2003. "External Constraints on Monetary Policy and the Financial Accelerator," NBER Working Papers 10128, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. Paul Krugman, 1999. "Balance Sheets, the Transfer Problem, and Financial Crises," International Tax and Public Finance, Springer, vol. 6(4), pages 459-472, November. [Downloadable!] (restricted)
  6. Luis Felipe Cespedes & Roberto Chang & Andres Velasco, 2000. "Balance Sheets and Exchange Rate Policy," NBER Working Papers 7840, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  7. Roberto Chang & Andres Velasco, 1998. "Financial Fragility and the Exchange Rate Regime," NBER Working Papers 6469, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  8. Oscar Jorda, 2005. "Estimation and Inference of Impulse Responses by Local Projections," American Economic Review, American Economic Association, vol. 95(1), pages 161-182, March. [Downloadable!] (restricted)
  9. Ivan Tchakarov & Paul Bergin, 2003. "Does Exchange Rate Risk Matter for Welfare?," Computing in Economics and Finance 2003 61, Society for Computational Economics. [Downloadable!]
    Other versions:
  10. Chang, R. & Velasco, A., 1998. "Financial Fragility and the Exchange Rate Regime," Working Papers 98-05, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
  11. Martin Schneider & Aaron Tornell, 2004. "Balance Sheet Effects, Bailout Guarantees and Financial Crises," Review of Economic Studies, Blackwell Publishing, vol. 71, pages 883-913, 07. [Downloadable!] (restricted)
    Other versions:
  12. Roberto Chang & Andres Velasco, 1998. "Financial Crises in Emerging Markets," NBER Working Papers 6606, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  13. Schmitt-Grohe, Stephanie & Uribe, Martin, 2004. "Solving dynamic general equilibrium models using a second-order approximation to the policy function," Journal of Economic Dynamics and Control, Elsevier, vol. 28(4), pages 755-775, January. [Downloadable!] (restricted)
    Other versions:
  14. Guillermo A. Calvo & Carmen M. Reinhart, 2000. "Fear of Floating," NBER Working Papers 7993, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  15. Anders Bergvall, 2005. "Exchange rate regimes and macroeconomic stability: the case of Sweden," Oxford Economic Papers, Oxford University Press, vol. 57(3), pages 422-446, July. [Downloadable!] (restricted)
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