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Financial Frictions and Real Devaluations

  • Alvaro Aguirre
  • César Calderón
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    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.

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    Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 318.

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    Date of creation: May 2005
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    Handle: RePEc:chb:bcchwp:318
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    1. Gian Maria Milesi-Ferrett & Assaf Razin, 1998. "Current Account Reversals and Currency Crises: Empirical Regularities," NBER Working Papers 6620, National Bureau of Economic Research, Inc.
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    10. Christiano, Lawrence J. & Gust, Christopher & Roldos, Jorge, 2004. "Monetary policy in a financial crisis," Journal of Economic Theory, Elsevier, vol. 119(1), pages 64-103, November.
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    14. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-25, August.
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