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Devaluations and Growth: The Role of Financial Development

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  • David Perez-Reyna

    (Universidad de los Andes)

  • Filippo Rebessi

    (California State University, East Bay)

Abstract

In this paper we rationalize the observation that in emerging markets an exchange rate devaluation might have a negative effect on production, due to the fact that the increase in the value of liabilities denominated in foreign currency causes a tightening in the domestic financial conditions, potentially offsetting the effect of an increase in the value of exports. We build on \cite{Melitz2003} to propose a model with heterogeneous firms in a small open economy where firms face financial frictions when borrowing from abroad. Depending on how strong the friction is, a foreign shock that results in an exchange rate devaluation might translate into lower output, even if exports increase.

Suggested Citation

  • David Perez-Reyna & Filippo Rebessi, 2018. "Devaluations and Growth: The Role of Financial Development," 2018 Meeting Papers 1118, Society for Economic Dynamics.
    • Handle: RePEc:red:sed018:1118
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    References listed on IDEAS

    as
    1. Jeremy Greenwood & Juan M. Sanchez & Cheng Wang, 2010. "Financing Development: The Role of Information Costs," American Economic Review, American Economic Association, vol. 100(4), pages 1875-1891, September.
    2. Fernando Leibovici, 2021. "Financial Development and International Trade," Journal of Political Economy, University of Chicago Press, vol. 129(12), pages 3405-3446.
    3. Mr. Daniel Leigh & Weicheng Lian & Mr. Marcos Poplawski Ribeiro & Rachel Szymanski & Viktor Tsyrennikov & Hong Yang, 2017. "Exchange Rates and Trade: A Disconnect?," IMF Working Papers 2017/058, International Monetary Fund.
    4. Francisco J. Buera & Joseph P. Kaboski & Yongseok Shin, 2011. "Finance and Development: A Tale of Two Sectors," American Economic Review, American Economic Association, vol. 101(5), pages 1964-2002, August.
    5. Valentina Bruno & Hyun Song Shin, 2015. "Cross-Border Banking and Global Liquidity," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 82(2), pages 535-564.
    6. Minetti, Raoul & Zhu, Susan Chun, 2011. "Credit constraints and firm export: Microeconomic evidence from Italy," Journal of International Economics, Elsevier, vol. 83(2), pages 109-125, March.
    7. Jonathan Kearns & Nikhil Patel, 2016. "Does the financial channel of exchange rates offset the trade channel?," BIS Quarterly Review, Bank for International Settlements, December.
    8. Marc J. Melitz, 2003. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," Econometrica, Econometric Society, vol. 71(6), pages 1695-1725, November.
    9. Demidova, Svetlana & Rodríguez-Clare, Andrés, 2013. "The simple analytics of the Melitz model in a small economy," Journal of International Economics, Elsevier, vol. 90(2), pages 266-272.
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