{
  "title": "Transcript of an IMF Economic Forum: Contractionary Currency Crashes in Developing Countries -- The Mundell-Fleming Lecture, IMF Annual Research Conference (Jeffrey A. Frankel, November 5, 2004)",
  "publication": "IMF News, November 5, 2004",
  "sourceUrl": "https://www.imf.org/en/news/articles/2015/09/28/04/54/tr041105",
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  "summary": "Lecture theme: political costs of devaluations; why devaluations are often contractionary in emerging markets; what countries can do to reduce vulnerability.",
  "publishDate": "2004-11-05",
  "sections": [
    {
      "heading": "Overview",
      "content": "- Lecture theme: political costs of devaluations; why devaluations are often contractionary in emerging markets; what countries can do to reduce vulnerability.\n- Three related papers/points framed around (1) political costs, (2) contractionary effects, (3) reducing vulnerability (short run and long run)."
    },
    {
      "heading": "Political costs of devaluation",
      "content": "- Historical benchmark: Richard Cooper (1972) statistic — leaders lose their job 30 percent of the time within the year following a devaluation; control group 14 percent.\n- Updated methodology: threshold for a “currency crash” raised to 25 percent; requires acceleration relative to preceding year and new crash if none in prior three years.\n- Key empirical findings:\n  - Leader turnover:\n    - Within six months of a devaluation: 23 percent lose office versus 12 percent in normal periods.\n    - Within 12 months of a devaluation: 29 percent versus 20 percent in normal periods (a 45-percent increase; not quite statistically significant at conventional levels).\n  - Finance ministers and central bank governors:\n    - Normal times: 35.8-percent probability of losing job.\n    - Within 12 months of a devaluation: 58.3 percent.\n  - Broken-promise effect:\n    - If leaders/ministers/governors publicly promised not to devalue in the preceding month: executives lost office half the time within six months; two-thirds within 12 months.\n    - If no such promise: about one-fifth within six months; one-third within 12 months.\n- Conditioning on IMF programs (±3 months): IMF program presence did not materially change the elevated post-devaluation turnover rates — among countries with IMF programs the leader lost office 21 percent of the time, similar to full sample."
    },
    {
      "heading": "Why devaluations are often contractionary (mechanisms discussed)",
      "content": "- Candidate mechanisms (many require rapid passthrough):\n  - Imported inputs: devaluation raises import-input prices (e.g., oil) → adverse supply shock.\n  - Consumer-price & wage pass-through: CPI rise combined with real wage rigidity or indexed wages → adverse effects on non-traded sectors.\n  - Sectoral redistribution: relative price changes alter income distribution; if winners have lower marginal propensity to consume, aggregate demand may fall.\n  - Real balances effect: general price-level rise reduces real money supply → contractionary.\n- Balance-sheet effects (emphasized):\n  - Currency mismatch: firms/banks borrow in foreign currency while revenues are in local currency → devaluation sharply raises local-currency cost of servicing foreign debt.\n  - Empirical association: magnitude of foreign-denominated debt × magnitude of depreciation correlates strongly with output losses (graphical evidence noted for cases such as Indonesia ’97, Bulgaria ’96).\n  - Terminology clarified: “original sin” (Hausmann/Eichengreen) denotes structural inability to borrow in local currency; currency mismatch and balance-sheet vulnerability arise from foreign-currency exposure."
    },
    {
      "heading": "Passthrough evidence (Shang-Jin Wei, David Parsley, Jeffrey Frankel work)",
      "content": "- Distinguish import-price passthrough at dock vs. retail vs. CPI; avoid composition bias by using narrowly defined products across many countries (e.g., branded cognac, Marlboro carton, Time magazine).\n- Empirical results (sample starting in 1990):\n  - Passthrough to import prices at the dock: 80 percent.\n  - Passthrough to identical imported goods at retail: ~50 percent (described as “just over 40 percent” in regressions).\n  - Local competitors and CPI: lower passthrough than dock/import-price measures.\n  - Cross-country pattern: higher passthrough historically for less developed countries; at start of sample passthrough ~0.8 for developing countries versus 0.3 for rich countries.\n  - Time trends: strong downward trends in passthrough over the 1990s — estimated declines of 0.25 per year for rich countries and an additional 0.5 per year for developing countries (sum = 0.75 per year in raw specification); historic average passthrough during the sample ~0.5.\n  - Many usual determinants (income per capita, tariffs, distance, wages, inflation) explain part of differences but do not fully explain the large downward trend, especially for poorer countries."
    },
    {
      "heading": "Short-run vulnerability: the “procrastination phase” (sudden stop dynamics)",
      "content": "- Empirical characterization:\n  - Period between peak of reserves (inflows cease) and full crash (25-percent depreciation) typically lasts six to 13 months.\n  - During this phase countries frequently:\n    - Publicly assert “no devaluation.”\n    - Run down official reserves.\n    - Shift debt maturity from long term to short term.\n    - Shift currency composition toward foreign currency (example: Mexico ’93–’94).\n- Mexico ’94 specifics:\n  - Rapid shift toward dollar-linked debt (tesobonos); by late 1994 tesobonos relative measure reached 70 percent (tesobonos/(tesobonos + cetes) measure).\n  - Maturity shifted from long-term toward short-term in the two years prior to the crash.\n- Common feature and policy implication:\n  - These procrastination strategies can buy time and sometimes succeed if external conditions improve, but they also worsen balance-sheet vulnerability and increase the chance that any eventual devaluation will be contractionary.\n  - Lesson: after inflows cease, adjust to the new external balance promptly rather than gambling for resurrection, to preserve balance sheets and the ability to use conventional expenditure-switching/expenditure-reducing policy mixes."
    },
    {
      "heading": "Long-run structural mitigation: trade openness and crises",
      "content": "- Question: does greater openness to trade raise or reduce vulnerability to sudden stops and currency crashes?\n- Arguments in favor of openness reducing vulnerability:\n  - Higher trade/GDP implies smaller required real adjustment to restore external balance for a given loss of inflows.\n  - Bilateral trade ties can act as “hostages,” lowering creditor fears of default (Eaton & Gersovitz; Andy Rose evidence).\n- Empirical approach (Cavallo & Frankel):\n  - Use gravity-model instrument for trade openness (trade/GDP) to address endogeneity of trade.\n  - Results:\n    - Greater trade openness is associated with lower likelihood of sudden stops and currency crashes; effect strengthens with gravity IV.\n    - Quantitative statement: an increase in trade openness of 10 percentage points decreases the likelihood of a sudden stop by approximately 32 percent (example scale: difference between Argentina and Australia).\n    - Evidence also suggests openness reduces output costs associated with currency crashes."
    },
    {
      "heading": "Takeaways (three main conclusions)",
      "content": "- Political costs: Updating Cooper — leaders, finance ministers, and central bank governors are substantially more likely to lose office after a devaluation; effects are larger when prior public assurances against devaluation exist but elevated turnover occurs even without prior promises.\n- Passthrough and contraction channels: passthrough coefficients declined sharply over the 1990s (the lecture cites “over the last 12 years”); thus contractionary effects are less likely to operate primarily through rapid CPI/import-price passthrough and more likely through currency mismatch and real-balance/balance-sheet effects.\n- Policy implications to avoid contractionary currency crashes:\n  - Short run: avoid weakening balance sheets during the procrastination phase—adjust promptly after inflows cease rather than gambling for resurrection.\n  - Long run: structurally increase trade openness to reduce vulnerability to sudden stops and currency crashes.\n\nTranscript of The Mundell-Fleming Lecture delivered by Jeffrey A. Frankel, Washington, D.C., November 5, 2004 — IMF External Relations Department (Public Affairs, Media Relations).\n\n---\n\n\n References\n\n- Argentina and the IMF\n- Brazil and the IMF\n- Indonesia and the IMF\n- Republic of Korea and the IMF\n- Mexico and the IMF\n- Thailand and the IMF\n- Transcripts\n- Annual IMF Research Conferences\n- Research at the IMF\n- IMF Seminars, Conferences, and Workshops\n- PRESS CENTER\n- https://www.imf.org/en/home\n\nSource: https://www.imf.org/en/news/articles/2015/09/28/04/54/tr041105"
    }
  ],
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    "[Markdown version](/en/news/articles/2015/09/28/04/54/tr041105/index.md)",
    "[Structured JSON version](/en/news/articles/2015/09/28/04/54/tr041105/index.json)",
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    "Published: November 5, 2004",
    "Lecture theme: political costs of devaluations; why devaluations are often contractionary in emerging markets; what countries can do to reduce vulnerability.",
    "Three related papers/points framed around (1) political costs, (2) contractionary effects, (3) reducing vulnerability (short run and long run).",
    "Historical benchmark: Richard Cooper (1972) statistic — leaders lose their job 30 percent of the time within the year following a devaluation; control group 14 percent.",
    "Updated methodology: threshold for a “currency crash” raised to 25 percent; requires acceleration relative to preceding year and new crash if none in prior three years.",
    "Key empirical findings:",
    "Conditioning on IMF programs (±3 months): IMF program presence did not materially change the elevated post-devaluation turnover rates — among countries with IMF programs the leader lost office 21 percent of the time, similar to full sample.",
    "Candidate mechanisms (many require rapid passthrough):",
    "Balance-sheet effects (emphasized):",
    "Distinguish import-price passthrough at dock vs. retail vs. CPI; avoid composition bias by using narrowly defined products across many countries (e.g., branded cognac, Marlboro carton, Time magazine).",
    "Empirical results (sample starting in 1990):",
    "Empirical characterization:",
    "Mexico ’94 specifics:",
    "Common feature and policy implication:",
    "Question: does greater openness to trade raise or reduce vulnerability to sudden stops and currency crashes?",
    "Arguments in favor of openness reducing vulnerability:",
    "Empirical approach (Cavallo & Frankel):",
    "Political costs: Updating Cooper — leaders, finance ministers, and central bank governors are substantially more likely to lose office after a devaluation; effects are larger when prior public assurances against devaluation exist but elevated turnover occurs even without prior promises.",
    "Passthrough and contraction channels: passthrough coefficients declined sharply over the 1990s (the lecture cites “over the last 12 years”); thus contractionary effects are less likely to operate primarily through rapid CPI/import-price passthrough and more likely through currency mismatch and real-balance/balance-sheet effects.",
    "Policy implications to avoid contractionary currency crashes:",
    "[Argentina and the IMF](http://www.imf.org/external/country/ARG/index.htm)",
    "[Brazil and the IMF](http://www.imf.org/external/country/BRA/index.htm)",
    "[Indonesia and the IMF](http://www.imf.org/external/country/IDN/index.htm)",
    "[Republic of Korea and the IMF](http://www.imf.org/external/country/KOR/index.htm)",
    "[Mexico and the IMF](http://www.imf.org/external/country/MEX/index.htm)",
    "[Thailand and the IMF](http://www.imf.org/external/country/THA/index.htm)",
    "[Transcripts](https://www.imf.org/en/news/searchnews)",
    "[Annual IMF Research Conferences](https://www.imf.org/External/Pubs/FT/staffp/2004/00-00/arc.htm)",
    "[Research at the IMF](https://www.imf.org/external/pubs/res/index.htm)",
    "[IMF Seminars, Conferences, and Workshops](https://www.imf.org/external/np/exr/seminars/index.htm)",
    "[PRESS CENTER](http://presscenter.imf.org/)",
    "[https://www.imf.org/en/home](https://www.imf.org/en/home)"
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