Limits of Floating Exchange Rates: the Role of Foreign Currency Debt and Import Structure

February 1, 2011

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Format: Chicago

Pascal Towbin, and Sebastian Weber. Limits of Floating Exchange Rates: the Role of Foreign Currency Debt and Import Structure, (USA: International Monetary Fund, 2011) accessed November 21, 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

A traditional argument in favor of flexible exchange rates is that they insulate output better from real shocks, because the exchange rate can adjust and stabilize demand for domestic goods through expenditure switching. This argument is weakened in models with high foreign currency debt and low exchange rate pass-through to import prices. The present study evaluates the empirical relevance of these two factors. We analyze the transmission of real external shocks to the domestic economy under fixed and flexible exchange rate regimes for a broad sample of countries in a Panel VAR and let the responses vary with foreign currency indebtedness and import structure. We find that flexible exchange rates do not insulate output better from external shocks if the country imports mainly low pass-through goods and can even amplify the output response if foreign indebtedness is high.

Subject: Exchange rate arrangements, Exchange rate flexibility, External debt, Foreign currency debt, Imports

Keywords: Balance sheet, Expenditure switching, Foreign currency, Terms of trade, WP

Publication Details

Pages:

51
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2011/042
Stock No:

WPIEA2011042
ISBN:

9781455219001
ISSN:

1018-5941

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