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Balance sheets and exchange rate policy

Cespedes, Luis Felipe, Chang, Roberto and Velasco Branes, Andres (2000) Balance sheets and exchange rate policy. NBER Working Paper Series (7840). National Bureau of Economic Research, Cambridge, MA.

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Identification Number: 10.3386/w7840

Abstract

We study the relation among exchange rates, balance sheets, and macroeconomic outcomes in a small open economy. Because liabilities are dollarized,' a real devaluation has detrimental effects on entreprenurial net worth, which in turn constrains investment due to financial frictions. But there is an offsetting effect, int hat devaluation expands home output and the return to domestic investment, which are also components of net worth. We show that the impact of an adverse foreign shock can be strongly magnified by the balance sheet effect of the associated real devaluation. But the fall in output employment, and investment is stronger under fixed exchange rates than under flexible rates. Hence the conventional wisdom, that flexible exchange rates are better absorbers of real foreign shocks than are fixed rates, holds in spite of potentially large balance sheet effects.

Item Type: Monograph (Working Paper)
Additional Information: © 2000 The Authors
Divisions: School of Public Policy
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Subjects: H Social Sciences > HG Finance
JEL classification: F - International Economics > F3 - International Finance > F30 - General
F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F40 - General
E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E40 - General
E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E50 - General
Date Deposited: 11 Oct 2019 15:12
Last Modified: 20 Nov 2019 05:12
URI: http://eprints.lse.ac.uk/id/eprint/102067

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