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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)

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 exchange rate regimes.

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File URL: http://www.econ.uconn.edu/working/2006-27r.pdf
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File URL: http://www.econ.uconn.edu/working/2006-27.pdf
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Bibliographic Info

Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2006-27.

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Length: 45 pages
Date of creation: Aug 2006
Date of revision: Aug 2008
Handle: RePEc:uct:uconnp:2006-27

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Related research

Keywords: accelerator; balance sheets; welfare; EMBI;

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References

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  1. Paul R. Bergin & Ivan Tchakarov, 2003. "Does Exchange Rate Risk Matter for Welfare?," NBER Working Papers 9900, National Bureau of Economic Research, Inc.
  2. Mark Gertler & Simon Gilchrist & Fabio M. Natalucci, 2007. "External Constraints on Monetary Policy and the Financial Accelerator," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(2-3), pages 295-330, 03.
  3. Roberto Chang & Andres Velasco, 1998. "Financial crises in emerging markets: a canonical model," Working Paper 98-10, Federal Reserve Bank of Atlanta.
  4. Alicia Garcia Herrero & Juan Carlos Berganza & Roberto Chang, 2004. "Balance Sheet Effects And The Country Risk Premium: An Empirical Investigation," International Finance 0403005, EconWPA.
  5. Òscar Jordà, 2005. "Estimation and Inference of Impulse Responses by Local Projections," American Economic Review, American Economic Association, vol. 95(1), pages 161-182, March.
  6. Roberto Chang & Andres Velasco, 1998. "Financial Crises in Emerging Markets," NBER Working Papers 6606, National Bureau of Economic Research, Inc.
  7. 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.
  8. Martin Schneider & Aaron Tornell, 2000. "Balance SHeet Effects, Bailout Guarantees and Financial Crises," NBER Working Papers 8060, National Bureau of Economic Research, Inc.
  9. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  10. 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.
  11. Luis Felipe Céspedes & Roberto Chang & Andrés Velasco, 2004. "Balance Sheets and Exchange Rate Policy," American Economic Review, American Economic Association, vol. 94(4), pages 1183-1193, September.
  12. 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.
  13. 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.
  14. Paul Krugman, 1999. "Balance Sheets, the Transfer Problem, and Financial Crises," International Tax and Public Finance, Springer, vol. 6(4), pages 459-472, November.
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Citations

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Cited by:
  1. Aysun, Uluc & Honig, Adam, 2011. "Bankruptcy costs, liability dollarization, and vulnerability to sudden stops," Journal of Development Economics, Elsevier, vol. 95(2), pages 201-211, July.
  2. Uluc Aysun & Ryan Brady & Adam Honig, 2011. "Financial Frictions and the Credit Channel of Monetary Transmission," Working Papers 2011-03, University of Central Florida, Department of Economics.

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