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

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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.

Suggested Citation

  • Pascal Towbin & Sebastian Weber, 2010. "Limits of Floats: The Role of Foreign Currency Debt and Import Structure," IHEID Working Papers 01-2010, Economics Section, The Graduate Institute of International Studies, revised Jan 2010.
    • Handle: RePEc:gii:giihei:heidwp01-2010
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    Cited by:

    1. Lahura, Erick & Vega, Marco, 2013. "Regímenes cambiarios y desempeño macroeconómico: Una evaluación de la literatura," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 26, pages 101-119.
    2. Filipa Sa & Pascal Towbin & Tomasz Wieladek, 2011. "Low interest rates and housing booms: the role of capital inflows, monetary policy and financial innovation," Globalization Institute Working Papers 79, Federal Reserve Bank of Dallas.
    3. Ülke, Volkan, 2015. "The Degree of Currency Substitution and Exchange Rate Pass-Through," MPRA Paper 75633, University Library of Munich, Germany, revised 15 Dec 2015.
    4. Aiyar, Shekhar & Calomiris , Charles W & Wieladek, Tomasz, 2012. "Does macropru leak? Evidence from a UK policy experiment," Bank of England working papers 445, Bank of England.
    5. Abbritti, Mirko & Weber, Sebastian, 2010. "Labor market institutions and the business cycle - unemployment rigidities vs. real wage rigidities," Working Paper Series 1183, European Central Bank.

    More about this item

    Keywords

    Exchange Rate Regimes; Balance Sheet Effects; Pass-through; Interacted Panel VAR; External Shocks;
    All these keywords.

    JEL classification:

    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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