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Exchange Rate Adjustment in Financial Crises

Author

Listed:
  • Michael B. Devereux

    (University of British Columbia
    NBER and CEPR)

  • Changhua Yu

    (Peking University)

Abstract

This paper studies the positive and normative effects of alternative monetary and exchange rate polices in a small open economy model subject to occasional “sudden stops” associated with binding borrowing constraints. Borrowing constraints in the model depend on endogenous movements in asset prices. We find that in normal times, there is little difference between alternative exchange rate policies. But during a crisis, macroeconomic outcomes are far worse under a pegged exchange rate regime. Under some shock configurations, crises may be less frequent under a pegged exchange rate regime, but the worse performance during a crisis leads the pegged exchange regime to be inferior to the floating regimes. Finally, we show that in the presence of pecuniary externalities in asset prices, there may be a case for a fiscal authority to subsidize capital inflows at a constant rate. But the benefits of capital inflow subsidies are much weaker under pegged exchange rates.

Suggested Citation

  • Michael B. Devereux & Changhua Yu, 2017. "Exchange Rate Adjustment in Financial Crises," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 65(3), pages 528-562, August.
  • Handle: RePEc:pal:imfecr:v:65:y:2017:i:3:d:10.1057_s41308-017-0033-5
    DOI: 10.1057/s41308-017-0033-5
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Alessandro Rebucci & Chang Ma, 2019. "Capital Controls: A Survey of the New Literature," NBER Working Papers 26558, National Bureau of Economic Research, Inc.
    2. Nadav Ben Zeev, 2019. "Asymmetric Business Cycles In Emerging Market Economies," Working Papers 1909, Ben-Gurion University of the Negev, Department of Economics.
    3. Javier Bianchi & Louphou Coulibaly, 2023. "A Theory of Fear of Floating," Working Papers 796, Federal Reserve Bank of Minneapolis.
    4. Ben Zeev, Nadav, 2019. "Global credit supply shocks and exchange rate regimes," Journal of International Economics, Elsevier, vol. 116(C), pages 1-32.
    5. Keefe, Helena Glebocki & Shadmani, Hedieh, 2018. "Foreign exchange market intervention and asymmetric preferences," Emerging Markets Review, Elsevier, vol. 37(C), pages 148-163.
    6. Nadav Ben Zeev, 2017. "Exchange Rate Regimes And Sudden Stops," Working Papers 1712, Ben-Gurion University of the Negev, Department of Economics.
    7. Helena Glebocki Keefe & Sujata Saha, 2022. "Threshold effects of openness on real and nominal effective exchange rates in emerging and developing economies," The World Economy, Wiley Blackwell, vol. 45(5), pages 1386-1408, May.

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    More about this item

    Keywords

    E44; E52; F33; F38; F41;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F38 - International Economics - - International Finance - - - International Financial Policy: Financial Transactions Tax; Capital Controls
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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