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To devaluate or not to devalue? How East European countries responded to the outflow of capital in 1997-99 and in 2008-09

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  • Vladimir Popov

    () (New Economic School, Moscow)

Abstract

If there is a negative terms of trade or financial shock leading to the deterioration in the balance of payments, there are two basic options for a country that has limited foreign exchange reserves. First, a country can maintain a fixed exchange rate (or even a currency board) and wait until the reduction of foreign exchange reserves leads to the reduction of money supply: this will drive domestic prices down and stimulate exports, raise interest rates and stimulate the inflow of capital, and finally will correct the balance of payments. Second, the country can allow the devaluation of national currency – flexible exchange rate will automatically bring the balance of payments back into the equilibrium. Because national prices are less flexible than exchange rates, the first type of adjustment is associated with the greater reduction of output. The empirical evidence on East European countries and other transition economies for 1998-99 period (outflow of capital after the 1997 Asian and 1998 Russian currency crises and slowdown of output growth rates) suggests that the second type of policy response (devaluation) was associated with smaller loss of output than the first type (monetary contraction). 2008-09 developments provide additional evidence for this hypothesis.

Suggested Citation

  • Vladimir Popov, 2011. "To devaluate or not to devalue? How East European countries responded to the outflow of capital in 1997-99 and in 2008-09," Working Papers w0154, Center for Economic and Financial Research (CEFIR).
  • Handle: RePEc:cfr:cefirw:w0154
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    References listed on IDEAS

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    1. Nadja Kamhi & Vivek H. Dehejia, 2006. "An Assessment of the Currency Board Regime in Bosnia and Herzegovina," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 42(6), pages 46-58, December.
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    5. Steve H. Hanke, 2003. "The Argentine Straw Man: A Response to Currency Board Critics," Cato Journal, Cato Journal, Cato Institute, vol. 23(1), pages 47-57, Spring/Su.
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    9. Polterovich, Victor & Popov, Vladimir, 2003. "Accumulation of Foreign Exchange Reserves and Long Term Growth," MPRA Paper 20069, University Library of Munich, Germany.
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    Cited by:

    1. Popov, Vladimir, 2011. "Why transition economies did worse than others in 2008-09 recession?," MPRA Paper 32388, University Library of Munich, Germany.
    2. Popov, Vladimir, 2013. "Economic Miracle of Post-Soviet Space: Why Uzbekistan Managed to Achieve What No Other Post-Soviet State Achieved," MPRA Paper 48723, University Library of Munich, Germany.

    More about this item

    JEL classification:

    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies

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