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MISALIGNMENT, LIABILITIES DOLLARIZATION AND EXCHANGE RATE ADJUSTMENT IN LATIN AMERICA

Enrique Alberola ()

International Finance from University Library of Munich, Germany

Abstract: Exchange rates in Latin America display a large volatility, constitute a central element of the policy strategies and their evolution have an important impact on financial stability due to the dollarization of liabilities which most countries exhibit. However, assessments on equilibrium exchange rates are scarce in the region. This paper aims at both filling this gap and analysing the impact of the adjustment of the exchange rates to equilibrium on financial stability. Building on the methodology of Alberola et al (1999,2002), we show that the stock of net foreign assets and the evolution of productivity are the fundamentals underlying the behavior of the real exchange rate. Using an unobserved components methodology in a cointegration framework, a time-varying equilibrium real exchange rate is derived, and deviations from this equilibrium provide an estimate of the degree of multilateral misalignment. The results uncover among other things the large overvaluation of the Argentinean peso in 2001, which was only partially explained by the estimated dollar overvaluation. The adjustment of exchange rates in 2002 corrected this and, to a lesser extent, other misalignments. The final part of the paper addresses the impact of liability dollarization on the adjustment of exchange rates. It is argued that the real exchange rate will tend to overshoot its equilibrium level, due to the need to foster higher current account surplus in the aftermath of depreciation to make up for to the increase in liabilities. An adjustment to account for this effect is performed on the previous results. This overshooting, when coupled with sudden stops of capitals, may help explaining the higher volatility of real exchange rates in the region.

Keywords: Equilibrium Exchange Rates; Liabilities dollarization; Overshooting (search for similar items in EconPapers)
JEL-codes: F31 F41 C23 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ifn and nep-mon
Date: 2005-07-08
Note: Type of Document - pdf; pages: 29. published as Chapter 13 in the book La Europeización del sistema político español, Carlos Closa (ed.) Editorial Istmo-Akal, Madrid 2001
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Citations: View citations in EconPapers (13) Track citations by RSS feed

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Working Paper: Misalignment, liabilities dollarization and exchange rate adjustment in Latin America (2003) Downloads
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