Global credit supply shocks and exchange rate regimes

The recent global financial crisis has re-emphasized the need for better understanding the relation between the type of exchange rate regime (ERR) in place and the effects of global credit supply shocks. Recent advances in the measurement of such shocks and their large realizations in the recent financial crisis produce a suitable quasi-natural experiment for studying this relation. Toward this end, I use ERR classification data for a panel of 40 emerging market economies (EMEs) to establish the following main findings: output responds significantly more adversely to contractionary global credit supply shocks in the fixed ERR than in the non-fixed ERR; deleveraging and the fall in imports are much more severe in the fixed ERR; and the lack of exchange rate depreciation in the fixed ERR is accompanied by a stronger fall in exports. These results are broadly consistent with predictions from models which include both the expenditure-switching channel and the balance sheet channel of exchange rate depreciation, where the latter channel effectively becomes expansionary, rather than contractionary as commonly thought, owing to favorable effects of the expenditure-switching channel on balance sheets' asset side.