What Hurts Most? G-3 Exchange Rate or Interest Rate Volatility

Carmen Reinhart and Vincent Reinhart

No 8535, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: With many emerging market currencies tied to the U.S. dollar either implicitly or explicitly, movements in the exchange values of the currencies of major countries have the potential to influence the competitive position of many developing countries. According to some analysts, establishing target bands to reduce the variability of the G-3 currencies would limit those destabilizing shocks emanating from abroad. This paper examines the argument for such a target zone strictly from an emerging market perspective. Given that sterilized intervention by industrial economies tends to be ineffective and that policy makers show no appetite to return to the controls on international capital flows that helped keep exchange rates stable over the Bretton Woods era, a commitment to damping G-3 exchange rate fluctuations requires a willingness on the part of G-3 authorities to use domestic monetary policy to that end. Under a system of target zones, then, relative prices for emerging market economies may become more stable, but debt-servicing costs may become less predictable. We use a simple trade model to show that the resulting consequences for welfare are ambiguous. Our empirical work supplements the traditional literature on North-South links by examining the importance of the volatilities of G-3 exchange-rates, and U.S. interest rate and consumption on capital flows and economic growth in developing countries over the past thirty years.

JEL-codes: F21 F32 (search for similar items in EconPapers)
Date: 2001-10
New Economics Papers: this item is included in nep-cba and nep-ifn
Note: IFM
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (71)

Published as Edwards, Sebastian and Jeffrey Frankel (eds.) Preventing Currency Crises in Emerging Markets. Chicago: University of Chicago Press for the NBER, 2001.

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Related works:
Working Paper: Twin Fallacies About Exchange Rate Policy in Emerging Markets (2003)
Working Paper: Twin fallacies about exchange rate policy: A note (2003)
Working Paper: Twin fallacies about exchange rate policy in emerging markets (2003)
Chapter: What Hurts Emerging Markets Most? G3 Exchange Rate or Interest Rate Volatility? (2002)
Working Paper: Una banda cambiaria en el G–3 ¿Es lo mejor para los mercados emergentes? (2002)
Working Paper: What hurts most?: G-3 exchange rate or interest rate volatility (2001)
Working Paper: What does a G-3 target zone mean for emerging-market economies? (2000)
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