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Exchange Rate Based Stabilization with Sudden Restrictions on Capital Flows

  • Chetan Subramanian
  • Jungsoo Park

This study examines the dynamics associated with an economy implementing an Exchange Rate Based Stabilization (ERBS) programs when they are subject to sudden restrictions in international capital flows. In the context of a simple theoretical model, we describe the pressures on a country's central bank, implementing such a program, to sell its foreign exchange reserves when the country experiences an unanticipated shock in the form of an external borrowing constraint. The theory and the empirical investigation in the paper support the view that current account deficits coupled with sudden restrictions on capital flows can account for several of the stylized facts associated with the ERBS plans. The analysis is particularly successful in explaining the reserve and real interest rate dynamics observed prior to the collapse of these plans, a feature which has largely been ignored by the ERBS literature. The paper also captures the more well documented boom-bust cycles associated with these programs

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Paper provided by Econometric Society in its series Econometric Society 2004 Far Eastern Meetings with number 748.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:feam04:748
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  1. Andrew Atkeson & Jose-Victor Rios-Rull, 1995. "The Balance of Payments and Borrowing Constraints: An Alternative View of the Mexican Crisis," NBER Working Papers 5329, National Bureau of Economic Research, Inc.
  2. Guillermo A. Calvo & Enrique G. Mendoza, 1996. "Mexico's balance-of-payments crisis: a chronicle of death foretold," International Finance Discussion Papers 545, Board of Governors of the Federal Reserve System (U.S.).
  3. Guillermo Calvo & Carlos A. Végh Gramont, 1991. "Exchange-Rate-Based Stabilization under Imperfect Credibility," IMF Working Papers 91/77, International Monetary Fund.
  4. Reinhart, Carmen M. & Vegh, Carlos A., 1995. "Nominal interest rates, consumption booms, and lack of credibility: A quantitative examination," Journal of Development Economics, Elsevier, vol. 46(2), pages 357-378, April.
  5. Calvo, Guillermo A. & Vegh, Carlos A., 1994. "Stabilization dynamics and backward-looking contracts," Journal of Development Economics, Elsevier, vol. 43(1), pages 59-84, February.
  6. Rebelo, S. & Vegh, C.A., 1995. "Real Effects of Exchange-Rate-Based Stabilization: An Analysis of Competing Theories," RCER Working Papers 405, University of Rochester - Center for Economic Research (RCER).
  7. Carlos A. Végh Gramont & Guillermo Calvo & Carmen Reinhart, 1994. "Targeting the Real Exchange Rate; Theory and Evidence," IMF Working Papers 94/22, International Monetary Fund.
  8. Reinhart, Carmen & Calvo, Guillermo & Leiderman, Leonardo, 1993. "“Capital Inflows and Real Exchange Rate Appreciation in Latin America: The Role of External Factors," MPRA Paper 7125, University Library of Munich, Germany.
  9. Guillermo A. Calvo & Carlos A. Vegh, 1999. "Inflation Stabilization and BOP Crises in Developing Countries," NBER Working Papers 6925, National Bureau of Economic Research, Inc.
  10. Gian-Maria Milesi-Ferretti & Assaf Razin, 1998. "Current Account Reversals and Currency Crisis; Empirical Regularities," IMF Working Papers 98/89, International Monetary Fund.
  11. Reinhart, Carmen & Kaminsky, Graciela & Vegh, Carlos, 2003. "The unholy trinity of financial contagion," MPRA Paper 13878, University Library of Munich, Germany.
  12. Guillermo Calvo & Carlos A. Végh Gramont, 1990. "Credibility and the Dynamics of Stabilization Policy; A Basic Framework," IMF Working Papers 90/110, International Monetary Fund.
  13. Maurice Obstfeld, 1984. "Capital Controls, The Dual Exchange Rate, and Devaluation," NBER Working Papers 1324, National Bureau of Economic Research, Inc.
  14. Frankel, Jeffrey A. & Rose, Andrew K., 1996. "Currency crashes in emerging markets: An empirical treatment," Journal of International Economics, Elsevier, vol. 41(3-4), pages 351-366, November.
  15. Laura Alfaro, 1999. "Why governments implement Temporary Stabilization Programs," Journal of Applied Economics, Universidad del CEMA, vol. 0, pages 211-245, November.
  16. A. Javier Hamann, 1999. "Exchange-Rate-Based Stabilization; Acritical Look At the Stylized Facts," IMF Working Papers 99/132, International Monetary Fund.
  17. Carlos A. Végh Gramont, 1991. "Stopping High Inflation; An Analytical Overview," IMF Working Papers 91/107, International Monetary Fund.
  18. Calvo, Guillermo A., 1981. "Devaluation: Levels versus rates," Journal of International Economics, Elsevier, vol. 11(2), pages 165-172, May.
  19. Guidotti, Pablo E. & Vegh, Carlos A., 1992. "Macroeconomic interdependence under capital controls : A two-country model of dual exchange rates," Journal of International Economics, Elsevier, vol. 32(3-4), pages 353-367, May.
  20. Kumhof, Michael, 2000. "A quantitative exploration of the role of short-term domestic debt in balance of payments crises," Journal of International Economics, Elsevier, vol. 51(1), pages 195-215, June.
  21. Calvo, Guillermo A, 1986. "Temporary Stabilization: Predetermined Exchange Rates," Journal of Political Economy, University of Chicago Press, vol. 94(6), pages 1319-29, December.
  22. Carlos A. Végh, 1992. "Stopping High Inflation: An Analytical Overview," IMF Staff Papers, Palgrave Macmillan, vol. 39(3), pages 626-695, September.
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