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Can Flexible Exchange Rates Still “Work” In Financially Open Economies?

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  • Ilan GOLDFAJN
  • Gino OLIVARES

Abstract

Recent studies have shown that exchange rates in developing countries have limited flexibility. In this paper we review the existing explanations for this stylized fact, using a simple framework of monetary policy in a world where firms face balance sheet effects and the economy has a high pass-through from depreciation to inflation. We estimate a panel regression using quarterly data in the period 1990–1999 for a sample of 46 countries (19 industrial and 27 developing), and find that the use of the exchange rate to buffer external shocks depends crucially on (i) on the degree of integration with capital markets, and (ii) the quality of external financing. We conclude that flexible regimes are viable in financially open economies, provided external financing is not based on very volatile capital. This, of course, is dependent on the establishment of credible macroeconomic policies.

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Bibliographic Info

Paper provided by United Nations Conference on Trade and Development in its series G-24 Discussion Papers with number 8.

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Date of creation: 2001
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Handle: RePEc:unc:g24pap:8

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  1. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  2. Ricardo Hausmann & Michael Gavin & Carmen Pagés-Serra & Ernesto H. Stein, 1999. "Financial Turmoil and Choice of Exchange Rate Regime," Research Department Publications, Inter-American Development Bank, Research Department 4170, Inter-American Development Bank, Research Department.
  3. Ilan Goldfajn & Poonam Gupta, 1999. "Does monetary policy stabilize the exchange rate following a currency crisis?," Textos para discussão, Department of Economics PUC-Rio (Brazil) 396, Department of Economics PUC-Rio (Brazil).
  4. Mishkin, Frederic S., 1998. "International Experiences With Different Monetary Policy Regimes," Seminar Papers, Stockholm University, Institute for International Economic Studies 648, Stockholm University, Institute for International Economic Studies.
  5. Burnside, Craig & Eichenbaum, Martin & Rebelo, Sergio, 2001. "Hedging and financial fragility in fixed exchange rate regimes," European Economic Review, Elsevier, Elsevier, vol. 45(7), pages 1151-1193.
  6. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange Rates and Financial Fragility," NBER Working Papers 7418, National Bureau of Economic Research, Inc.
  7. Laurence Ball, 2000. "Policy Rules and External Shocks," Working Papers Central Bank of Chile, Central Bank of Chile 82, Central Bank of Chile.
  8. Andres Velasco & Roberto Chang, 2000. "Exchange-Rate Policy for Developing Countries," American Economic Review, American Economic Association, American Economic Association, vol. 90(2), pages 71-75, May.
  9. Alberto Alesina & Vittorio Grilli & Gian Maria Milesi-Ferrett, 1993. "The Political Economy of Capital Controls," NBER Working Papers 4353, National Bureau of Economic Research, Inc.
  10. Ricardo Hausmann & Ugo Panizza & Ernesto H. Stein, 2000. "Why Do Countries Float the Way They Float?," IDB Publications 6467, Inter-American Development Bank.
  11. Paul Krugman, 1999. "Balance Sheets, the Transfer Problem, and Financial Crises," International Tax and Public Finance, Springer, Springer, vol. 6(4), pages 459-472, November.
  12. A Alesina & V Grilli & G Milesi-Feretti, 1993. "The Political Economy of Capital Controls," CEP Discussion Papers dp0169, Centre for Economic Performance, LSE.
  13. Dani Rodrik & Andres Velasco, 1999. "Short-Term Capital Flows," NBER Working Papers 7364, National Bureau of Economic Research, Inc.
  14. Ricardo J. Caballero & Arvind Krishnamurthy, 2000. "Dollarization of Liabilities: Underinsurance and Domestic Financial Underdevelopment," NBER Working Papers 7792, National Bureau of Economic Research, Inc.
  15. Reinhart, Carmen & Calvo, Guillermo, 2001. "Fixing for your life," MPRA Paper 13873, University Library of Munich, Germany.
  16. P. Krugman & L. Taylor, 1976. "Contractionary Effects of Devaluations," Working papers, Massachusetts Institute of Technology (MIT), Department of Economics 191, Massachusetts Institute of Technology (MIT), Department of Economics.
  17. Reinhart, Carmen, 2000. "The mirage of floating exchange rates," MPRA Paper 13736, University Library of Munich, Germany.
  18. Frankel, Jeffrey & Schmukler, Sergio L. & Serven, Luis, 2004. "Global transmission of interest rates: monetary independence and currency regime," Journal of International Money and Finance, Elsevier, Elsevier, vol. 23(5), pages 701-733, September.
  19. Vittorio Grilli & Gian Maria Milesi-Ferretti, 1995. "Economic Effects and Structural Determinants of Capital Controls," IMF Staff Papers, Palgrave Macmillan, vol. 42(3), pages 517-551, September.
  20. repec:fth:inadeb:418 is not listed on IDEAS
  21. Andrew Berg & Paolo Mauro & Michael Mussa & Alexander K. Swoboda & Esteban Jadresic & Paul R. Masson, 2000. "Exchange Rate Regimes in an Increasingly Integrated World Economy," IMF Occasional Papers 193, International Monetary Fund.
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Cited by:
  1. Carrera, Jorge Eduardo & Cicowiez, Martín & Lacunza, Hernán & Saavedra, Marcelo, 2005. "Interdependencia y regímenes cambiarios en Mercosur: un modelo macroeconómico de equilibrio general computado para su medición
    [Interdependence under different exchange rate regimes in the Merco
    ," MPRA Paper 7845, University Library of Munich, Germany, revised 2005.
  2. Siwei Goo & Reza Siregar, 2009. "Economic Shocks And Exchange Rate As A Shock Absorber In Indonesia And Thailand," Staff Papers, South East Asian Central Banks (SEACEN) Research and Training Centre, number sp72, June.

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