Exchange Rate Flexibility and Credit during Capital Inflow Reversals: Purgatory…not Paradise

April 16, 2014

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Format: Chicago

Nicolas E Magud, and Esteban Vesperoni. Exchange Rate Flexibility and Credit during Capital Inflow Reversals: Purgatory…not Paradise, (USA: International Monetary Fund, 2014) accessed December 4, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

We document the behavior of macro and credit variables during episodes of capital inflows reversals in economies with different degrees of exchange rate flexibility. We find that exchange rate flexibility is associated with milder credit growth during the boom but, even though smaller than in more rigid regimes, it cannot shield the economy from a credit reversal. Furthermore, we observe what we dub as a recovery puzzle: credit growth in economies with more flexible exchange rate regimes remains tepid well after the capital flow reversal takes place. This results stress the complementarity of macro-prudential policies with the exchange rate regime. More flexible regimes could help smoothing the credit cycle through capital surchages and dynamic provisioning that build buffers to counteract the credit recovery puzzle. In contrast, more rigid exchange rate regimes would benefit the most from measures to contain excessive credit growth during booms, such as reserve requirements, loan-to-income ratios, and debt-to-income and debt-service-to-income limits.

Subject: Bank credit, Capital inflows, Credit, Exchange rate arrangements, Exchange rate flexibility

Keywords: Banking sector credit, Credit growth, Exchange rate regime, WP

Publication Details

Pages:

30
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2014/061
Stock No:

WPIEA2014061
ISBN:

9781475543735
ISSN:

1018-5941

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