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Financial Constraints and Exchange Rate Flexibility in Emerging Market Economies

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  • Michael B. Devereux

    (Hong Kong Institute for Monetary Research, University of British Columbia, CEPR)

Abstract

Empirical evidence from the Asian financial crisis of 1997-1998 suggests that exchange rate depreciation may have had a contractionary effect on the traded good sector of the worst-hit economies. Many writers have suggested that this was caused by exchange rate sensitive credit constraints affecting the production sector. This paper documents some of this evidence, and uses it to develop a structural model that features an important role for credit constraints in the financing of traded goods production. We show that this model can explain why emerging market governments would be more concerned with variations in exchange rates than would be implied by standard ¡¥optimal currency area¡¦ criteria. Moreover, the model implies that monetary policy may be a very ineffective tool in emerging market economies.

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Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 152001.

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Length: 30 pages
Date of creation: Dec 2001
Date of revision:
Handle: RePEc:hkm:wpaper:152001
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Find related papers by JEL classification:

  • F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General
  • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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  1. 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.
  2. Guillermo A. Calvo & Carmen M. Reinhart, 2000. "Fear of Floating," NBER Working Papers 7993, National Bureau of Economic Research, Inc.
  3. Luis Felipe Céspedes & Roberto Chang & Andrés Velasco, 2004. "Balance Sheets and Exchange Rate Policy," American Economic Review, American Economic Association, vol. 94(4), pages 1183-1193, September.
  4. McKinnon, Ronald I. & Pill, Huw, 1998. "International Overborrowing: A Decomposition of Credit and Currency Risks," World Development, Elsevier, vol. 26(7), pages 1267-1282, July.
  5. Roberto Chang & Andrés Velasco, 1999. "Liquidity Crises in Emerging Markets: Theory and Policy," Documentos de Trabajo 59, Centro de Economía Aplicada, Universidad de Chile.
  6. Aghion, Philippe & Bacchetta, Philippe & Banerjee, Abhijit, 2001. "Currency crises and monetary policy in an economy with credit constraints," European Economic Review, Elsevier, vol. 45(7), pages 1121-1150.
  7. Mishkin, Frederic S. & Savastano, Miguel A., 2001. "Monetary policy strategies for Latin America," Policy Research Working Paper Series 2685, The World Bank.
  8. Holger C. Wolf & Alberto Giovannini & Jose De Gregorio, 1994. "International Evidenceon Tradables and Nontradables Inflation," IMF Working Papers 94/33, International Monetary Fund.
  9. Chang, R. & Velasco, A., 1998. "Financial Fragility and the Exchange Rate Regime," Working Papers 98-05, C.V. Starr Center for Applied Economics, New York University.
  10. Mendoza, Enrique G, 2001. "The Benefits of Dollarization When Stabilization Policy Lacks Credibility and Financial Markets Are Imperfect," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(2), pages 440-74, May.
  11. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange Rates and Financial Fragility," NBER Working Papers 7418, National Bureau of Economic Research, Inc.
  12. David Backus & Patrick J. Kehoe & Finn E. Kydland, 1992. "Dynamics of the Trade Balance and the Terms of Trade: The S-Curve," NBER Working Papers 4242, National Bureau of Economic Research, Inc.
  13. Martin Schneider & Aaron Tornell, 2000. "Balance SHeet Effects, Bailout Guarantees and Financial Crises," NBER Working Papers 8060, National Bureau of Economic Research, Inc.
  14. Stephanie Schmitt-Grohe & Martin Uribe, 2000. "Stabilization Policy and the Costs of Dollarization," Departmental Working Papers 200006, Rutgers University, Department of Economics.
  15. Paul Krugman, 1999. "Balance Sheets, the Transfer Problem, and Financial Crises," International Tax and Public Finance, Springer, vol. 6(4), pages 459-472, November.
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Cited by:

  1. Choi, Woon Gyu & Cook, David, 2004. "Liability dollarization and the bank balance sheet channel," Journal of International Economics, Elsevier, vol. 64(2), pages 247-275, December.

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