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Limits of Floats: The Role of Foreign Currency Debt and Import Structure

Pascal Towbin and Sebastian Weber ()

No 01-2010, IHEID Working Papers from Economics Section, The Graduate Institute of International Studies

Abstract: 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 a model with high foreign currency debt and low exchange rate pass through to import prices. 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.

Keywords: Exchange Rate Regimes; Balance Sheet Effects; Pass-through; Interacted Panel VAR; External Shocks (search for similar items in EconPapers)
JEL-codes: E30 F33 F34 F41 (search for similar items in EconPapers)
Pages: 38 pages
Date: 2010-01-10, Revised 2010-01
New Economics Papers: this item is included in nep-cba and nep-mon
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