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Automatic Stabilizer Feature of Fixed Exchange Rate Regimes in Emerging Markets

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  • 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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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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Web page: http://www.econ.uconn.edu/
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Related research

Keywords: accelerator; balance sheets; welfare; EMBI;

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References

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  1. 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.
  2. 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.
  3. Juan Carlos Berganza & Roberto Chang & Alicia García Herrero, 2003. "Balance sheet effects and the country risk premium: an empirical investigation," Banco de España Working Papers 0316, Banco de España.
  4. Luis Felipe Cespedes & Roberto Chang & Andres Velasco, 2000. "Balance Sheets and Exchange Rate Policy," NBER Working Papers 7840, National Bureau of Economic Research, Inc.
  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. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  7. Martin Schneider & Aaron Tornell, 2004. "Balance Sheet Effects, Bailout Guarantees and Financial Crises," Review of Economic Studies, Wiley Blackwell, vol. 71, pages 883-913, 07.
  8. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Solving Dynamic General Equilibrium Models Using a Second-Order Approximation to the Policy Function," NBER Technical Working Papers 0282, National Bureau of Economic Research, Inc.
  9. 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.
  10. Paul Krugman, 1999. "Balance Sheets, the Transfer Problem, and Financial Crises," International Tax and Public Finance, Springer, vol. 6(4), pages 459-472, November.
  11. Roberto Chang & Andres Velasco, 1998. "Financial Fragility and the Exchange Rate Regime," NBER Working Papers 6469, National Bureau of Economic Research, Inc.
  12. Paul R. Bergin & Ivan Tchakarov, 2003. "Does Exchange Rate Risk Matter for Welfare?," NBER Working Papers 9900, National Bureau of Economic Research, Inc.
  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. Roberto Chang & Andres Velasco, 1998. "Financial Crises in Emerging Markets," NBER Working Papers 6606, National Bureau of Economic Research, Inc.
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Citations

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Cited by:
  1. 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.
  2. Uluc Aysun & Adam Honig, 2008. "Bankruptcy Costs, Liability Dollarization, and Vulnerability to Sudden Stops," Working papers 2008-41, University of Connecticut, Department of Economics.

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