Mundell-Fleming Lecture: Contractionary Currency Crashes in Developing Countries

By Jeffrey A. Frankel. International Monetary Fund Staff Papers, 2005

134 citations recorded by the source corpus.

To update a famous old statistic: a political leader in a developing country is almost twice as likely to lose office in the six months following a currency crash as otherwise. This difference, which is highly significant statistically, holds regardless of whether the devaluation takes place in the context of an IMF program. Why are devaluations so costly? Many of the currency crises of the last 10 years have been associated with output loss. Is this, as alleged, because of excessive reliance on raising the interest rate as a policy response? More likely it is because of contractionary effects of devaluation. There are various possible contractionary effects of devaluation, but it is appropriate that the balance sheet effect receives the most emphasis. Pass-through from exchange rate changes to import prices in developing countries is not the problem: this coefficient fell in the 1990s, as a look at some narrowly defined products shows. Rather balance sheets are the problem. How can countries mitigate the fall in output resulting from the balance sheet effect in crises? In the shorter term, adjusting promptly after inflows cease is better than procrastinating by shifting to short-term dollar debt, which raises the costliness of the devaluation when it finally comes. In the longer term, greater openness to trade reduces vulnerability to both sudden stops and currency crashes.

Subfields: Economics and Econometrics, Finance

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Citations in the corpus

Does High Inflation Cause Central Bankers to Lose Their Job? Evidence Based on a New Data Set (2007, background): “Frankel (2005) reports that in the year following a currency crash the finance minister or central bank governor – whoever held the office of the country’s governor of the IMF – often lost his job.”
Fear of appreciation (2007, background): “10 See, among others, Reinhart and Rogoff (2004) and Shambaugh (2004).”
The New Economics of Prudential Capital Controls: A Research Agenda (2011, background): “Empirical evidence suggests that exchange rate depreciations play a crucial role in creating balance sheet effects during crises in small open economies, and that emerging economies are particularly vulnerable to such crises (Frankel, 2005).”
Output Drops and the Shocks that Matter (2006, background): “First, we provide a broader perspective on the relative importance of various types of crisis that have been previously examined individually—such as banking, currency, and debt crises (see, for example, Dell’Ariccia and others, 2005; Milesi-Ferretti and Razin, 2000; and Frankel, 2005).”
Are Crises Good for Long-Term Growth? The Role of Political Institutions (2010, unknown): “15 See Frankel and Rose (1996), Frankel and Wei (2004), and Frankel (2005) for a discussion on currency crises and the links with other varieties of crises.”