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Automatic Stabilizer Feature of Fixed Exchange Rate Regimes in Emerging Markets

  • Uluc Aysun

    (University of Connecticut)

This paper shows that countries characterized by a financial accelerator mechanism may reverse the usual finding of the literature -- flexible exchange rate regimes do a worse job of insulating open economies from external shocks. I obtain this result with a calibrated small open economy model that endogenizes foreign interest rates by linking them to the banking sector's foreign currency leverage. This relationship renders exchange rate policy more important compared to the usual exogeneity assumption. I find empirical support for this prediction using the Local Projections method. Finally, 2nd order approximation to the model finds larger welfare losses under flexible exchange rate regimes.

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Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2006-27.

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Length: 45 pages
Date of creation: Aug 2006
Date of revision: Aug 2008
Handle: RePEc:uct:uconnp:2006-27
Contact details of provider: Postal: University of Connecticut 365 Fairfield Way, Unit 1063 Storrs, CT 06269-1063
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Fax: (860) 486-4463
Web page: http://www.econ.uconn.edu/

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  1. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  2. Roberto Chang & Andres Velasco, 1997. "Financial fragility and the exchange rate regime," Working Paper 97-16, Federal Reserve Bank of Atlanta.
  3. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Solving Dynamic General Equilibrium Models Using a Second-Order Approximation to the Policy Function," NBER Technical Working Papers 0282, National Bureau of Economic Research, Inc.
  4. Martin Schneider & Aaron Tornell, 2000. "Balance SHeet Effects, Bailout Guarantees and Financial Crises," NBER Working Papers 8060, National Bureau of Economic Research, Inc.
  5. Bernanke, Ben S. & Gertler, Mark & Gilchrist, Simon, 1999. "The financial accelerator in a quantitative business cycle framework," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 21, pages 1341-1393 Elsevier.
  6. 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.
  7. Chang, R. & Velasco, A., 1998. "Financial Crises in Emerging Markets: A Canonical Model," Working Papers 98-21, C.V. Starr Center for Applied Economics, New York University.
  8. Ivan Tchakarov & Paul Bergin, 2003. "Does Exchange Rate Risk Matter for Welfare?," Computing in Economics and Finance 2003 61, Society for Computational Economics.
  9. Roberto Chang & Andres Velasco, 1998. "Financial Crises in Emerging Markets," NBER Working Papers 6606, National Bureau of Economic Research, Inc.
  10. Òscar Jordà, 2005. "Estimation and Inference of Impulse Responses by Local Projections," American Economic Review, American Economic Association, vol. 95(1), pages 161-182, March.
  11. Mark Gertler & Simon Gilchrist & Fabio Natalucci, 2003. "External Constraints on Monetary Policy and the Financial Accelerator," NBER Working Papers 10128, National Bureau of Economic Research, Inc.
  12. Anders Bergvall, 2005. "Exchange rate regimes and macroeconomic stability: the case of Sweden," Oxford Economic Papers, Oxford University Press, vol. 57(3), pages 422-446, July.
  13. Juan Carlos Berganza & Roberto Chang & Alicia García Herrero, 2003. "Balance sheet effects and the country risk premium: an empirical investigation," Banco de Espa�a Working Papers 0316, Banco de Espa�a.
  14. 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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