External Shocks, Policies, and Tail-Shifts in Real Exchange Rates

June 23, 2023

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Format: Chicago

Nicolas E Magud, and Samuel Pienknagura. External Shocks, Policies, and Tail-Shifts in Real Exchange Rates, (USA: International Monetary Fund, 2023) accessed November 12, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

We use panel quantile regressions to study extreme (rather than average) movements in the distribution of the real effective exchange rate (REER) of small open economies. We document that global uncertainty (VIX) and global financial conditions (U.S. monetary policy) shocks have a strong impact on the distribution of the REER changes, with larger impacts in the tails of the distribution, and especially in economies with shallower FX markets, lower central bank credibility, and higher credit risk (i.e., weaker macro fundamentals). Foreign exchange intervention (FXI) partially offsets the impact of these shocks, especially in the left tail (large depreciations) and particularly in economies with weaker fundamentals but, more importantly, when FXI is used sporadically. Thus, our results highlight the importance of deepening FX markets, improving central bank credibility, and strengthening macro fundamentals against the potential dynamic trade-offs of overreliance on a policy that would exacerbate the previously mentioned frictions. While our results point to low effectiveness of capital flow management in preventing large REER movements, they seem to enable more impactful foreign exchange intervention in the immediate aftermath of shocks.

Subject: Currency markets, Depreciation, Financial markets, Foreign exchange, Foreign exchange intervention, National accounts, Real effective exchange rates, Real exchange rates

Keywords: Capital controls, Central bank credibility, Currency markets, Depreciation, External shocks, Foreign exchange intervention, FXI effectiveness, Global, IMF working paper 23/129, Real effective exchange rates, Real exchange rates, REER distribution, VIX shock

Publication Details

Pages:

51
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2023/129
Stock No:

WPIEA2023129
ISBN:

9798400247019
ISSN:

1018-5941

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