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Are depreciations as contractionary as devaluations? A comparison of selected emerging and industrial economies

  • Shaghil Ahmed
  • Christopher J. Gust
  • Steven B. Kamin
  • Jonathan Huntley

According to conventional models, flexible exchange rates play an equilibrating role in open economies, depreciating in response to adverse shocks, boosting net exports, and stimulating aggregate demand. However, critics argue that, at least in developing countries, devaluations are more contractionary and more inflationary than conventional theories would predict. Yet, it is not clear whether devaluations per se have led to adverse outcomes, or rather the disruptive abandonments of pegged exchange-rate regimes associated with devaluations. To explore this hypothesis, we estimate VAR models to compare the responses to devaluation of developing economies and two types of industrial economies: those that have consistently floated, and those that have sustained fixed exchange-rate regimes as well. We find that both of these types of industrial economies exhibit conventional (i.e., expansionary) responses to devaluation shocks, compared with the contractionary responses exhibited by developing countries. This finding suggests that exchange rate movements may be more destabilizing in developing countries than in industrial countries, regardless of exchange rate regime.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 737.

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Date of creation: 2002
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Handle: RePEc:fip:fedgif:737
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  1. J. Saul Lizondo & Peter J. Montiel, 1989. "Contractionary Devaluation in Developing Countries: An Analytical Overview," IMF Staff Papers, Palgrave Macmillan, vol. 36(1), pages 182-227, March.
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  4. Ricardo Hausmann & Ugo Panizza & Ernesto H. Stein, 2000. "Why Do Countries Float the Way They Float?," IDB Publications (Working Papers) 6467, Inter-American Development Bank.
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  12. Reinhart, Carmen & Calvo, Guillermo, 2001. "Fixing for your life," MPRA Paper 13873, University Library of Munich, Germany.
  13. Jeffrey A. Frankel, 1999. "No Single Currency Regime is Right for All Countries or At All Times," NBER Working Papers 7338, National Bureau of Economic Research, Inc.
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  17. Steven B. Kamin, 1998. "A multi-country comparison of the linkages between inflation and exchange rate competitiveness," International Finance Discussion Papers 603, Board of Governors of the Federal Reserve System (U.S.).
  18. Reinhart, Carmen & Calvo, Guillermo, 2001. "Reflections on Dollarization," MPRA Paper 8206, University Library of Munich, Germany.
  19. Alberto Alesina & Robert J. Barro, 2001. "Dollarization," American Economic Review, American Economic Association, vol. 91(2), pages 381-385, May.
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