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Financial Frictions and Real Devaluations

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  • Alvaro Aguirre
  • César Calderón

Abstract

In this paper I study the effects of real exchange rate devaluations on output performance using a sample of large devaluation episodes for a group of emerging and developed countries. I find that balance sheet effects, captured by the interaction between the real exchange rate devaluation and the level of external indebtedness of the country, have a significant and negative impact on output. Nevertheless, there is also evidence of a positive effect of the real devaluation associated to the traditional expansionary effect. For countries with large foreign-denominated external debt, the combined effect of the real exchange rate depreciation is likely to generate significant output losses in the short-run. However, in the medium term, the expansionary effect of the real devaluation tends to dominate the balance sheet effect, which implies a positive effect on output in the medium term. Finally, countries with deeper financial market experience lower output losses following a devaluation.

Suggested Citation

  • Alvaro Aguirre & César Calderón, 2005. "Financial Frictions and Real Devaluations," Working Papers Central Bank of Chile 318, Central Bank of Chile.
  • Handle: RePEc:chb:bcchwp:318
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