Exchange Rate, Capital Flow and Output: Developed versus Developing Economies
- 449 Downloads
This paper aims to study the impact of exchange rate and capital flows on output in one unifying model. To explore this issue, we apply a vector auto-regression (VAR) model with Cholesky decomposition to a group of developed economies (Canada, Switzerland, Australia, Italy, the Netherlands, and Spain) and developing economies (Mexico, Indonesia, Korea, Malaysia, Philippines, Brazil, and Chile). The sample period varies for each country with the longest for Switzerland (1970:1–2010:3) and the shortest for Chile (1996:1–2010:3). The findings suggest first that contractionary devaluation is more likely to happen in developing countries while expansionary devaluation is more prevalent in developed countries. Second, the current account tends to improve in some of the countries facing currency depreciation. However, whether output increases after a real devaluation or not has little to do with whether the current account improves or not. Third, in response to capital inflows, output in developed countries are largely unaffected, while output in developing countries generally increases.
KeywordsDevaluation Contractionary effects VAR model
- Abdelal, R., & Alfaro, L. (2003). Capital and control: lessons from Malaysia. International Finance and Trade, Challenge, 46(4), 36–53.Google Scholar
- Agenor, P. R., & Montiel, P. (1996). Development Macroeconomics. Princeton: Princeton University Press.Google Scholar
- Cooper, R. N. (1971). Currency Depreciation in Developing Countries. In: Princeton Essays in International Finance (86). Princeton University.Google Scholar
- Cowan, K. and De Gregorio, J. (2007). International Borrowing, Capital Controls, and the Exchange Rate: Lessons from Chile. Capital Controls and Capital Flows in Emerging Economies: Policies, Practices, and Consequences, National Bureau of Economic Research.Google Scholar
- Edwards, S. (1989). Real Exchange Rates, Devaluation, and Adjustment: Exchange Rate Policy in Developing Countries. Cambridge: MIT Press.Google Scholar
- Eichengreen, B., Hausmann, R., & Panizza, U. (2002). Original Sin: The Pain, the Mystery and the Road to Redemption, paper presented at a conference on “Currency and Maturity Matchmaking: Redeeming Debt from Original Sin”. Washington D.C: Inter-American Development Bank.Google Scholar
- Frankel, J. A. (1988). Ambiguous policy multipliers in theory and in empirical models. In R. C. Bryant, D.W. Henderson, G. Holtham, (Eds.), Empirical Macroeconomics for Interdependent Economies (pp. 17–26). Washington D.C.: The Brookings Institution.Google Scholar
- Frankel, J. A. (2005). Mundell-fleming lecture: contractionary currency crashes in developing countries. IMF Staff Papers, 52(2), 149–182.Google Scholar
- Giovanni, J. D., Gottselig, G., Jaumotte, F., Ricci, L. A. and Tokarick, S. (2008). Globalization: A Brief Overview, International Monetary Fund Issues Brief, Issue 02/08. https://www.imf.org/external/np/exr/ib/2008/053008.htm. Accessed 29 Dec 2014.
- Goldberg, L. S. and Klein, M. (1998). Foreign Direct Investment, Trade and Real Exchange Rate Linkages in Developing Countries. In Reuven Glick (Ed.), Managing Capital Flows and Exchange Rates: Perspectives from the Pacific Basin (pp. 73–100). Cambridge University PressGoogle Scholar
- Goldstein, M., & Khan, M. S. (1985). Income and price effects in foreign trade. Handbook of International Economics, 2, 1041–1105.Google Scholar
- Hagen, J. and Zhang, H. (2011). International Capital Flows and Aggregate Output. CEPR Discussion Paper, DP8400. Available at SSRN: http://ssrn.com/abstract=1853129.
- Investopedia Staff (2014). The Effects of Currency Fluctuations on the Economy. Investopedia. http://www.investopedia.com/articles/forex/080613/effects-currency-fluctuations-economy.asp. Accessed 29 Dec 2014.
- Johnson, S., Ostry, J. D., and Subramanian, A. (2006). The Prospects for Sustained Growth in Africa: Benchmarking the Constraints. NBER Working Paper, 13120.Google Scholar
- Kwan, C. H. (1994). Economic Interdependence in the Asia-Pacific Region: Towards a Yen Bloc. London: Routledge.Google Scholar
- Lee, J. Y. (1997). Sterilizing Capital Inflows. IMF Economic Issues, 7.Google Scholar
- Sharma, S. (2003). The Malaysian capital control regime of 1998: implementation, effectiveness, and lessons. Asian Perspective, 27(1), 77–108.Google Scholar
- Shi, J. (2006). Are Currency Appreciations Contractionary in China? NBER Working Paper, 12551.Google Scholar
- Upadhyaya, K. P., Dhakal, D. P., & Mixon, F. G. (2000). Exchange rate adjustment and output in selected Latin American countries. Economia Internazionale, 53(1), 107–117.Google Scholar