Atlantic Economic Journal

, Volume 43, Issue 2, pp 195–207 | Cite as

Exchange Rate, Capital Flow and Output: Developed versus Developing Economies

Article

Abstract

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.

Keywords

Devaluation Contractionary effects VAR model 

JEL

F30 

References

  1. Abdelal, R., & Alfaro, L. (2003). Capital and control: lessons from Malaysia. International Finance and Trade, Challenge, 46(4), 36–53.Google Scholar
  2. Agenor, P. R., & Montiel, P. (1996). Development Macroeconomics. Princeton: Princeton University Press.Google Scholar
  3. Aitken, B. J., & Harrison, A. E. (1999). Do domestic firms benefit from direct foreign investment? Evidence from Venezuela. American Economic Review, 89(3), 605–618.CrossRefGoogle Scholar
  4. Calvo, G. A., Leiderman, L., & Reinhart, C. M. (1996). Inflows of capital to developing countries in the 1990s. The Journal of Economic Perspectives, 10(2), 123–139.CrossRefGoogle Scholar
  5. Cooper, R. N. (1971). Currency Depreciation in Developing Countries. In: Princeton Essays in International Finance (86). Princeton University.Google Scholar
  6. 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
  7. Diaz-Alejandro, C. F. (1963). A note on the impact of devaluation and the redistributive effect. The Journal of Political Economy, 71(6), 577–580.CrossRefGoogle Scholar
  8. Edwards, S. (1986). Are devaluations contractionary? The Review of Economics and Statistics, 68(3), 501–508.CrossRefGoogle Scholar
  9. Edwards, S. (1989). Real Exchange Rates, Devaluation, and Adjustment: Exchange Rate Policy in Developing Countries. Cambridge: MIT Press.Google Scholar
  10. Eichengreen, B., & Sachs, J. (1985). Exchange rates and economic recovery in the 1930s. Journal of Economic History, 44(4), 925–946.CrossRefGoogle Scholar
  11. 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
  12. Findlay, R., & Rodriguez, C. A. (1977). Intermediated imports and macroeconomic policy under flexible exchange rates. Canadian Journal of Economics, 10(2), 208–217.CrossRefGoogle Scholar
  13. 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
  14. Frankel, J. A. (2005). Mundell-fleming lecture: contractionary currency crashes in developing countries. IMF Staff Papers, 52(2), 149–182.Google Scholar
  15. 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.
  16. 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
  17. Goldstein, M., & Khan, M. S. (1985). Income and price effects in foreign trade. Handbook of International Economics, 2, 1041–1105.Google Scholar
  18. Gylfason, T., & Radetzki, M. (1991). Does devaluation make sense in the least developed countries? Economic Development and Cultural Change, 40(1), 1–25.CrossRefGoogle Scholar
  19. Gylfason, T., & Risager, O. (1984). Does devaluation improve the current account? European Economic Review, 25, 37–64.CrossRefGoogle Scholar
  20. Gylfason, T., & Schmid, M. (1983). Does devaluation cause stagflation? The Canadian Journal of Economics, 16(4), 641–654.CrossRefGoogle Scholar
  21. Hagen, J. and Zhang, H. (2011). International Capital Flows and Aggregate Output. CEPR Discussion Paper, DP8400. Available at SSRN: http://ssrn.com/abstract=1853129.
  22. Hur, J., Raj, M., & Riyanto, Y. E. (2006). Finance and trade: a cross-country empirical analysis on the impact of financial development and asset tangibility on international trade. World Development, 34(10), 1728–1741.CrossRefGoogle Scholar
  23. 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.
  24. 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
  25. Kamin, S. B., & Rogers, J. H. (2000). Output and the real exchange rate in developing countries: an application to Mexico. Journal of Development Economics, 61(1), 85–109.CrossRefGoogle Scholar
  26. Kim, S., & Roubini, N. (2000). Exchange rate anomalies in the industrial countries: a solution with a structural VAR approach. Journal of Monetary Economics, 45(3), 561–586.CrossRefGoogle Scholar
  27. Kim, Y., & Ying, Y. H. (2001). An empirical analysis on capital flows: the case of Korea and Mexico. Southern Economic Journal, 67(4), 954–968.CrossRefGoogle Scholar
  28. Kim, Y., & Ying, Y. H. (2007). An empirical assessment of currency devaluation in East Asian countries. Journal of International Money and Finance, 26(2), 265–283.CrossRefGoogle Scholar
  29. Kwan, C. H. (1994). Economic Interdependence in the Asia-Pacific Region: Towards a Yen Bloc. London: Routledge.Google Scholar
  30. Lartey, E. K. K. (2008). Capital inflows, resource reallocation and the real exchange rate. International Finance, 11(2), 131–152.CrossRefGoogle Scholar
  31. Lee, J. Y. (1997). Sterilizing Capital Inflows. IMF Economic Issues, 7.Google Scholar
  32. Mejía-Reyes, P., Osborn, D. R., & Sensier, M. (2010). Modeling real exchange rate effects on output performance in Latin America. Applied Economics, 42(19), 2491–2503.CrossRefGoogle Scholar
  33. Narayan, P. K. (2006). Examining the relationship between trade balance and exchange rate: the case of China’s trade with the USA. Applied Economics Letters, 13(8), 507–510.CrossRefGoogle Scholar
  34. Reinhart, C. M. (2000). The mirage of floating exchange rates. American Economic Review, 90(2), 65–70.CrossRefGoogle Scholar
  35. Shahbaz, M., Islam, F., & Aamir, N. (2012). Is devaluation contractionary? Empirical evidence for Pakistan. Economic Change and Restructuring, 45(4), 299–316.CrossRefGoogle Scholar
  36. Sharma, S. (2003). The Malaysian capital control regime of 1998: implementation, effectiveness, and lessons. Asian Perspective, 27(1), 77–108.Google Scholar
  37. Shi, J. (2006). Are Currency Appreciations Contractionary in China? NBER Working Paper, 12551.Google Scholar
  38. Sims, C. A. (1980). Macroeconomics and reality. Econometrica, 48, 1–48.CrossRefGoogle Scholar
  39. Stiglitz, J. E. (2004). Capital-market liberalization, globalization, and the IMF. Oxford Review of Economic Policy, 20(1), 57–71.CrossRefGoogle Scholar
  40. Upadhyaya, K. P., & Upadhyay, M. P. (1999). Output effects of devaluation: evidence from Asia. The Journal of Development Studies, 35(6), 89–103.CrossRefGoogle Scholar
  41. 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

Copyright information

© International Atlantic Economic Society 2015

Authors and Affiliations

  1. 1.Department of EconomicsCalifornia State University, FresnoFresnoUSA
  2. 2.Department of Economics and GeographyCoggin College of Business, University of North FloridaJacksonvilleUSA
  3. 3.Department of EconomicsUniversity of KentuckyLexingtonUSA

Personalised recommendations