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Exchange Rate Based Stabilization with Sudden Restrictions on Capital Flows

Chetan Subramanian and Jungsoo Park ()

No 748, Econometric Society 2004 Far Eastern Meetings from Econometric Society

Abstract: This study examines the dynamics associated with an economy implementing an Exchange Rate Based Stabilization (ERBS) programs when they are subject to sudden restrictions in international capital flows. In the context of a simple theoretical model, we describe the pressures on a country's central bank, implementing such a program, to sell its foreign exchange reserves when the country experiences an unanticipated shock in the form of an external borrowing constraint. The theory and the empirical investigation in the paper support the view that current account deficits coupled with sudden restrictions on capital flows can account for several of the stylized facts associated with the ERBS plans. The analysis is particularly successful in explaining the reserve and real interest rate dynamics observed prior to the collapse of these plans, a feature which has largely been ignored by the ERBS literature. The paper also captures the more well documented boom-bust cycles associated with these programs

Keywords: Exchange rate; inflation; capital flows; borrowing constraints (search for similar items in EconPapers)
JEL-codes: E52 F32 F41 (search for similar items in EconPapers)
Date: 2004-08-11
New Economics Papers: this item is included in nep-ifn
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