Limits of Floating Exchange Rates : the Role of Foreign Currency Debt and Import Structure

Author/Editor:

Pascal Towbin ; Sebastian Weber

Publication Date:

February 1, 2011

Electronic Access:

Free Download. Use the free Adobe Acrobat Reader to view this PDF file

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

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 models with high foreign currency debt and low exchange rate pass-through to import prices. The present study evaluates the empirical relevance of these two factors. 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.

Series:

Working Paper No. 11/42

Subject:

English

Publication Date:

February 1, 2011

ISBN/ISSN:

9781455219001/1018-5941

Stock No:

WPIEA2011042

Format:

Paper

Pages:

51

Please address any questions about this title to publications@imf.org