Exchange Market Pressure and Monetary Policy in Emerging Market Economies: New Evidence from Treatment-effect Estimations

Alexander Erler, Steffen Sirries, Christian Bauer and Bernhard Herz

Review of Development Economics, 2015, vol. 19, issue 3, 470-485

Abstract: The way central banks react to exchange market pressure is likely to affect the subsequent economic development and the associated economic costs. In a situation of currency pressure the central bank can in principle decide to let the currency float freely, to maintain the peg or to implement a managed float policy, i.e. a mix of depreciation and intervention. As the central bank's choices are subject to self selection and endogeneity, we use propensity score matching to adequately cope with these methodical challenges. We find that monetary authorities have two options to keep down the economic costs in terms of output, namely stabilizing the exchange rate or letting the currency float freely. In contrast, a managed float under currency pressure is accompanied by the worst possible outcome with an average loss of gross domestic product (GDP) between 5% and 6%.

Date: 2015
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