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Shock persistence and the choice of foreign exchange regime - an empirical note from Mexico

  • Giugale, Marcelo
  • Korobow, Adam
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    The academic and policy debate about optimal foreign exchange rate regimes for emerging economies, has focused more on the theoretical costs and benefits of possible regimes, than on their actual performance. The authors report on what can be called exchange-rate-regime-dependent differential shock persistence - that is, the time output takes to return to its trend after a negative shock - in a sample of countries representing various points on the spectrum of nominal foreign exchange flexibility. They find strong evidence that Mexico's stimulated output recovery after a negative external shock was faster (a third as long) when the country's policymakers let the nominal foreign exchange rate float, than when they fixed it, and much faster than in other developing countries that kept nominal foreign exchange rates constant, especially those that resorted to currency board arrangements to support that constancy. These results are insufficient to guide the choice of regime (they lack general equilibrium value, and are based on a limited sample of countries), but they highlight an important practical consideration in making that choice: How long it takes for output to adjust after negative shocks, is sensitive to the level of rigidity of the foreign exchange regime. This factor may be critical when the social costs of those adjustments are not negligible.

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    Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2371.

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    Date of creation: 31 Jul 2000
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    Handle: RePEc:wbk:wbrwps:2371
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    1. Jeffrey A. Rosensweig & Ellis W. Tallman, 1991. "Fiscal policy and trade adjustment: are the deficits really twins?," FRB Atlanta Working Paper 91-2, Federal Reserve Bank of Atlanta.
    2. Tamim Bayoumi and Barry Eichengreen., 1992. "Macroeconomic Adjustment Under Bretton Woods and the Post-Bretton-Woods Float: An Impulse- Response Analysis," Economics Working Papers 92-201, University of California at Berkeley.
    3. Mayadunne, Geetha & Evans, Merran & Inder, Brett, 1995. "An Empirical Investigation of Shock Persistence in Economic Time Series," The Economic Record, The Economic Society of Australia, vol. 71(213), pages 145-56, June.
    4. Caporale, Guglielmo Maria & Pittis, Nikitas, 1995. "Nominal exchange rate regimes and the stochastic behavior of real variables," Journal of International Money and Finance, Elsevier, vol. 14(3), pages 395-415, June.
    5. David E. Runkle, 1987. "Vector autoregressions and reality," Staff Report 107, Federal Reserve Bank of Minneapolis.
    6. David Felix, 1998. "On Drawing General Policy Lessons from Recent Latin American Currency Crises," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 20(2), pages 191-221, January.
    7. Robert P. Flood & Robert J. Hodrick, 1985. "Real Aspects of Exchange Rate Regime Choice with Collapsing Fixed Rates," NBER Working Papers 1603, National Bureau of Economic Research, Inc.
    8. Atsuyuki Naka & David Tufte, 1997. "Examining impulse response functions in cointegrated systems," Applied Economics, Taylor & Francis Journals, vol. 29(12), pages 1593-1603.
    9. Runkle, David E, 1987. "Vector Autoregressions and Reality: Reply," Journal of Business & Economic Statistics, American Statistical Association, vol. 5(4), pages 454, October.
    10. Osakwe, Patrick N. & Schembri, Lawrence L., 2002. "Real effects of collapsing exchange rate regimes: an application to Mexico," Journal of International Economics, Elsevier, vol. 57(2), pages 299-325, August.
    11. Caporale, Guglielmo Maria & Kalyvitis, Sarantis & Pittis, Nikitas, 1994. "Persistence in real variables under alternative exchange rate regimes : Some multi-country evidence," Economics Letters, Elsevier, vol. 45(1), pages 93-102, May.
    12. Lutkepohl, Helmut & Reimers, Hans-Eggert, 1992. "Impulse response analysis of cointegrated systems," Journal of Economic Dynamics and Control, Elsevier, vol. 16(1), pages 53-78, January.
    13. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
    14. Runkle, David E, 1987. "Vector Autoregressions and Reality," Journal of Business & Economic Statistics, American Statistical Association, vol. 5(4), pages 437-42, October.
    15. repec:oup:qjecon:v:97:y:1982:i:1:p:43-66 is not listed on IDEAS
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