{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Larrain e Velasco - Exchange Rate Policy

Larrain e Velasco - Exchange Rate Policy - Exchange Rate...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
Exchange Rate Policy in Emerging Markets: The Case for Floating * Felipe Larraín B. Pontificia Universidad Católica de Chile and Harvard University Andrés Velasco Harvard University, Universidad de Chile and National Bureau of Economic Research This version April 2001 * We thank Domingo Cavallo, Jacques De Larosiere, Gerardo Esquivel, Cristina Garcia, Gene Grossman, Ricardo Hausmann, Peter Kenen, Dani Rodrik, Jose Tavares, and two anonymous referees for comments on earlier drafts. Velasco is grateful to the Center for International Development at Harvard University; Larraín to the Dirección de Investigaciones y Postgrado (DIPUC) and the VRA Research Fund, both of the Pontificia Universidad Católica de Chile, for logistical support. Ximena Clark provided efficient research assistance. An earlier version of this paper was prepared for the Group of 30.
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
1 1. Introduction What exchange rate arrangements should developing countries adopt? This old question was given new urgency by the 1997-98 Asian crisis, with its offshoots in Eastern Europe and Latin America. Arrangements that had performed relatively well for years (think of Indonesia and Korea) came crashing down with almost no advance notice; other arrangements that once seemed invulnerable (think of Hong-Kong’s currency board), almost tumbled down as well. Mid-course corrections and policy changes proved equally troublesome: in every country that abandoned a peg and floated (Brazil, Russia, Ecuador, Thailand, again Indonesia and Korea, and now Turkey), the exchange rate overshot massively and a period of currency turmoil followed. All of it with tremendous real costs: both the high interest rates used to defend pegs and the massive depreciations that followed abandonment played havoc with corporate balance sheets and wrecked large chunks of the domestic financial system. Adjustable or crawling pegs were in place in almost every country that experienced serious difficulties recently: first in Thailand, Indonesia and Korea, then in Russia, Brazil, Ecuador and Turkey. The pressure brought by massive capital flow reversals and weakened domestic financial systems was too much to bear, even for countries that followed reasonably sound macro policies and had seemingly plentiful reserves. One possible reaction is to argue that the pegs that collapsed were not pegged enough : lack of credibility and the resulting endemically high interest rates eventually brought these fixed rates down, the logic goes. Then the answer is to ensure credibility at any expense: hard pegs such as a currency board –or even full abandonment of the domestic currency— should help convince skeptics. After all, one cannot easily devalue a currency that does not exist, or one whose exchange rate is set by law. This logic helps explain the popularity of currency boards or dollarization, particularly in countries with an inflationary history and/or weak political institutions.
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

Page1 / 59

Larrain e Velasco - Exchange Rate Policy - Exchange Rate...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon bookmark
Ask a homework question - tutors are online