Devaluation and pass-through in indebted and risky economies

2006

This paper estimates a new open economy macroeconomic model for South Korea to determine the output effect of currency devaluations. Three transmission mechanisms are considered: the expenditure-switching, the balance sheet, and a monetary channel associated to a nominal exchange rate target. Devaluations are defined as an increase in this target.Thisallowstoisolatetheeffects of explicit exogenous devaluationary policy shocks from any other shock to the economy. Ceteris paribus, a devaluation is found to be expansionary. Hence, the devaluation did not cause South Korea’s output contraction but rather it was a different shock.

SSRN Electronic Journal, 2006

This paper estimates a new open economy macroeconomic model for South Korea to determine the output effect of currency devaluations. Three transmission mechanisms are considered: the expenditure-switching, the balance sheet, and a monetary channel associated to a nominal exchange rate target. Devaluations are defined as an increase in this target. This allows to isolate the effects of an explicit exogenous devaluationary policy shock. Ceteris paribus, a devaluation is found to be expansionary. Output contractions in South Korea should then be associated with a different shock such as an adverse shock on the international interest rate or on export demand.

Open Economies Review, 2007

Motivated by the experiences of Mexico and Argentina, we explore a model intended to capture the interactions among exchange rate policy, fiscal policy, and default on foreign currency-denominated debt. Our objective is to examine how exchange rate policy affects the supply of short-term debt facing the government. We show that under a conventional soft peg, it can be optimal for the government to choose a level of the exchange rate that may result in partial or complete debt default, as in the Mexican case. Paradoxically, default may also be an equilibrium outcome under a hard peg, as in the case of Argentina, precisely because devaluation is not an option. Multiple equilibria may exist under a soft peg, with one equilibrium featuring a high domestic interest rate, an overvalued exchange rate, a low level of output, and a high default probability. Under a hard peg, however, there is a unique equilibrium.

SSRN Electronic Journal, 2000

In this paper, a modified "early warning system" (EWS) approach is developed to identify the roles of domestic and external factors in emerging market crises. Several probit models of financial crises were estimated for 26 emerging market countries. These models were used to identify the separate contributions to the probabilities of crisis of domestic and external variables. We found that, relative to domestic factors, adverse external shocks and large external imbalances contributed little to the average estimated probability of crisis in emerging market countries, but accounted for much more of the spikes in the probability of crisis estimated to occur during actual crisis years. We interpret these results to suggest that while, on average over time, domestic factors have tended to contribute to much of the underlying vulnerability of emerging market countries, adverse swings in external factors may have been important in pushing economies "over the edge" and into financial crisis. In consequence, the costs of giving up exchange rate flexibility through adoption of strongly fixed exchange rate regimes-e.g., currency boards or dollarization-may be quite high for some countries. , "The Contributions of Domestic and External Factors to Latin American Devaluation Crises: An Early Warning Systems Approach." That paper developed and simulated a model of financial crises, based on data for six Latin American countries: Argentina, Brazil, Chile, Colombia, Mexico and Venezuela. For this paper, we have extended the database to 26 emerging market countries, and have introduced several (relatively minor) methodological changes as well.

2017

This paper reexamines aggregate and disaggregate import and export demand functions for Japan. This re-examination is warranted the country has undergone substantial structural transformation, particularly with regard to the East Asian production chain. In the long run, nonfuel goods imports are highly income sensitive, while the price elasticity is near unity. Goods exports are similarly income sensitive. The price elasticity is around 0.7. In these preferred specifications, the Marshall-Lerner conditions hold, so that an exchange rate depreciation results in an improved trade balance.

In the current period of devaluation pessimism, devaluation is often seen as an instrument to accommodate inflation instead of one to change the real exchange rate and support external balance. The authors argue that such pessimism has in some cases gone too far. The real exchange rate is an endogenous variable, and whether devaluation can change the real exchange rate depends on other factors. But devaluation is not always evil, say the authors, and in some cases it can improve macroeconomic performance. It is most effective if it corrects an initial situation where the currency is clearly overvalued. In low-inflation countries, devaluation is less likely to destabilize prices because there is less indexing. The authors examine the effect of maxi-devaluation in low-inflation countries on the real exchange rate, inflation, and growth. They use a sample of 33 maxi-devaluations (20 percent or larger) in economies that had low inflation before the devaluation and where the exchange rat...

The American Economic Review, 1978

The emergence of the portfolio balance approach 1 has led to a reformulation of the causes of balance-of-trade and payments disequilibria. According to this approach, balance-of-trade deficits and surpluses reflect discrepancies between desired and actual wealth holdings; while balance-of payments deficits and surpluses reflect discrepancies between desired and actual money holdings. Thus, balance-of-trade and payments disequilibria are viewed as representing disequilibria within the asset markets. Using this framework several authors2 have examined the self-correcting nature of disequilibria within the balance of-payments accounts and the ability of a devaluation to reduce the magnitude of a disequilibrium. Disciplines Economic Theory | International Economics | Other Economics Comments This is an article from The American Economic Review 68 (1978): 601. Posted with permission. This article is available at Iowa State University Digital Repository: http://lib.dr.iastate.edu/econ_las...

CEPAL Review, 2016

This paper develops a structural general equilibrium model to analyse the reactions of the nominal exchange rate and the domestic price level to three types of external shock in emerging economies that have limited access to world capital markets. Although the results depend crucially on the type of external shock, each of the two national balance-sheet parameters considered here-the risk premium and the ratio of external indebtedness-exacerbates the reactions of the two endogenous variables without altering the degree of exchange-rate pass-through (erpt). Moreover, flatter Phillips curves, as observed today in many economies, tend to increase erpt. On the basis of these results, the authorities of emerging economies seeking to stabilize markets and limit erpt are advised to minimize the two risk parameters by applying a flexible inflation-targeting regime.

Unpublished manuscript, Universidad …, 1999

This paper studies the effect of large devaluations on inflation. It analyzes a sample of 41 episodes of currency crisis. The data show that about 30% of the devaluation is offset by higher inflation after three months, and the offset climbs to about 60% after two years, with a significant real depreciation present for longer periods. The main determinants of the extent of inflationary pass-through of the devaluations and inflation are the position of output relative to trend, the extent of initial overvaluation, and mainly the initial rate of inflation. Our results explain well the evolution of inflation after currency crisis, except for the EMS crisis of 1992 that has a very low pass-through. We also analyze the inflationary impact of devaluations in the Asian crisis.