Destabilizing Stability? Exchange Rate Arrangements and Foreign Currency Debt

25 Pages Posted: 30 Oct 2020

See all articles by Balazs Csonto

Balazs Csonto

International Monetary Fund (IMF)

Date Written: August 2020

Abstract

Emerging markets (EMs) often respond to shocks by intervening in foreign exchange (FX) markets and thus preventing full exchange rate adjustment. This response can serve to dampen the effect of shocks and increase monetary policy space but may also incentivize economic participants to increase risk taking and take on more FX debt. This paper empirically analyzes the role of exchange rate flexibility in affecting such risk taking, by using rolling correlations and difference-in-difference estimations. The results suggest that a shift towards greater exchange rate flexibility often coincides with a decline in external FX debt. The findings also highlight the importance of using complementary policies to deal with financial stability issues related to the exchange rate, such as FX-specific macroprudential policies and policies aimed at promoting financial development.

Keywords: Exchange rate flexibility, Exchange rate arrangements, External debt, Foreign exchange, Exchange rates, WP, tag0, FX debt, mi, debt

JEL Classification: E52, E58, F31, F34, F40, O24

Suggested Citation

Csonto, Balazs, Destabilizing Stability? Exchange Rate Arrangements and Foreign Currency Debt (August 2020). IMF Working Paper No. 20/173, Available at SSRN: https://ssrn.com/abstract=3721197

Balazs Csonto (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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