Macroeconomic policies and financial shocks in dollarized economies

Emerging economies are usually affected by external shocks whose effects are amplified by internal vulnerabilities like imperfect credit markets, dollarization, and nominal rigidities. This dissertation analyses the stabilizing role of the exchange rate regime and the fiscal policy in this context. Read More

Emerging economies are usually affected by external shocks whose effects are amplified by internal vulnerabilities like imperfect credit markets, dollarization, and nominal rigidities. This dissertation analyses the stabilizing role of the exchange rate regime and the fiscal policy in this context. The first chapter analyzes this kind of problems providing a first extensive comparison between the Argentine and Uruguayan crises of 2001-2002. We show how the more flexible monetary policy in the Uruguayan case helps explain the better performance of Uruguay. Uruguay enjoyed better credit conditions during the recession. Different credit conditions seem to reflect a different reputation.
This situation and the different ways both countries handled the debt restructuring after the crisis had a long-lasting impact on the performance of both countries. The second chapter investigates the role played by external and internal forces in the recession events that happened during the Argentine Convertibility period (1991-2001) until its collapse. We find evidence of an important role of external shocks in the Russian crisis and in the end of the Convertibility. Internal vulnerabilities, related to Argentine idiosyncratic risk shocks, were also present during the Tequila crisis and in the Convertibility collapse.
Finally, chapter three studies the optimal combination of fiscal policy and exchange rate flexibility in a dollarized small open economy that has to cope with external shocks. Our analysis suggests that a countercyclical fiscal policy dominates other alternatives. The choice of the exchange rate regime is crucial only when fiscal policy is not countercyclical enough.


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Specifications


Publisher
Presses universitaires de Louvain
Author
José Mourelle,
Set
Language
English
BISAC Subject Heading
BUS028000 BUSINESS & ECONOMICS / Foreign Exchange > BUS113000 BUSINESS & ECONOMICS / Globalization
BIC subject category (UK)
KCM Development economics > KCX Financial crises & disasters
Onix Audience Codes
06 Professional and scholarly
CLIL (Version 2013-2019)
3306 Économie de la mondialisation et du développement > 3338 Risques, marchés financiers et assurance
Title First Published
20 January 2021
Subject Scheme Identifier Code
: Economie monétaire et financière
: Sciences économiques et sociales
: Sciences économiques

Paperback


Publication Date
20 January 2021
ISBN-13
9782390610960
Extent
Main content page count : 138
Code
101547
Dimensions
16 x 24 cm
Weight
232 grams
Packaging Type
No outer packaging
List Price
15.00 €
ONIX XML
Version 2.1, Version 3

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Contents


Acknowledgements xiii
General Introduction xv
1 Fiscal and exchange rate policies during the Argentine and Uruguayan crises of 2001-2002 1
1.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.2 Main explanations of the Argentine and Uruguayan crises . . . . . 2
1.2.1 Internal vulnerabilities. The balance sheet approach . . . . . 3
Dollarized balance sheets . . . . . . . . . . . . . . . . . . . . 3
1.2.2 Internal vulnerabilities. The role of macroeconomic policies 4
Fixed exchange rate regime . . . . . . . . . . . . . . . . . . . 4
Procyclical and non sustainable fiscal policies . . . . . . . . 5
1.2.3 External factors . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Capital inflows and sudden stops . . . . . . . . . . . . . . . 6
Lack of coordination inside the Mercosur process . . . . . . 6
1.3 Before the crisis. Argentina and Uruguay during the 1990's . . . . . 6
1.3.1 Monetary and exchange rate policy . . . . . . . . . . . . . . 7
The stabilisation plans . . . . . . . . . . . . . . . . . . . . . . 7
Real exchange rate appreciation . . . . . . . . . . . . . . . . 8
1.3.2 Fiscal policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Procyclicality of fiscal policies . . . . . . . . . . . . . . . . . . 9
Public debt dynamics in Argentina and Uruguay . . . . . . 10
Fiscal sustainability in Argentina and Uruguay . . . . . . . 12
Differences in reputation . . . . . . . . . . . . . . . . . . . . 14
1.3.3 Financial vulnerabilities in Argentina and Uruguay . . . . . 15
Currency substitution . . . . . . . . . . . . . . . . . . . . . . 15
Other related vulnerabilities . . . . . . . . . . . . . . . . . . . 16
1.3.4 A decade of regional integration and growth . . . . . . . . . 17
1.4 The crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
1.4.1 The beginning of the recession . . . . . . . . . . . . . . . . . 18
The capital flows reversal . . . . . . . . . . . . . . . . . . . . 18
The Brazilian devaluation . . . . . . . . . . . . . . . . . . . . 19
1.4.2 Activity drop . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
1.4.3 Exchange rate and fiscal policies . . . . . . . . . . . . . . . . 21
1.4.4 Financial deterioration . . . . . . . . . . . . . . . . . . . . . 23
1.5 Collapse and Recovery . . . . . . . . . . . . . . . . . . . . . . . . . . 24
1.5.1 The final stage . . . . . . . . . . . . . . . . . . . . . . . . . . 24
The end of the convertibility . . . . . . . . . . . . . . . . . . 24
The end of the Uruguayan peg . . . . . . . . . . . . . . . . . 26
1.5.2 Public debt restructuring process . . . . . . . . . . . . . . . 27
Argentina's Sovereign Debt Restructuring . . . . . . . . . . 27
Uruguay’s Sovereign Debt Restructuring . . . . . . . . . . . 28
1.5.3 Monetary and fiscal policies after crisis resolution . . . . . . 29
1.5.4 Some considerations about the crisis . . . . . . . . . . . . . 32
External shocks and internal vulnerabilities . . . . . . . . . 32
The crisis resolution . . . . . . . . . . . . . . . . . . . . . . . 33
1.6 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
1.7 Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
1.7.1 Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
1.7.2 Condition for Fiscal sustainability . . . . . . . . . . . . . . . 37
1.7.3 Testing fiscal sustainability in Argentina and Uruguay . . . 38
2 External and domestic shocks during the Argentine Convertibility and its collapse 43
2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
2.2 Modelling strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
2.2.1 A basic model . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
2.2.2 Structural shocks . . . . . . . . . . . . . . . . . . . . . . . . . 47
External shocks . . . . . . . . . . . . . . . . . . . . . . . . . . 47
Domestic shocks . . . . . . . . . . . . . . . . . . . . . . . . . 48
2.2.3 Local projections . . . . . . . . . . . . . . . . . . . . . . . . . 49
2.2.4 Historical decomposition . . . . . . . . . . . . . . . . . . . . 50
2.3 Estimation and results . . . . . . . . . . . . . . . . . . . . . . . . . . 50
2.3.1 Preliminary analysis . . . . . . . . . . . . . . . . . . . . . . . 50
2.3.2 Identification of shocks: VAR analysis . . . . . . . . . . . . . 51
2.3.3 Impulse response functions: Local projections . . . . . . . . 53
2.3.4 Historical decomposition . . . . . . . . . . . . . . . . . . . . 55
2.3.5 Episode analysis . . . . . . . . . . . . . . . . . . . . . . . . . 56
Tequila crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
Russian crisis and Brazilian devaluation . . . . . . . . . . . . 57
End of Convertibility . . . . . . . . . . . . . . . . . . . . . . . 58
2.4 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
2.5 Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
2.5.1 Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
External series . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
Domestic series . . . . . . . . . . . . . . . . . . . . . . . . . . 62
2.5.2 Historical decomposition . . . . . . . . . . . . . . . . . . . . 64
2.5.3 ADF test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
2.5.4 Benchmark variables. Convertibility period . . . . . . . . . . 66
3 Balance sheets and fiscal and exchange rate policies 67
3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
3.2 The model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
3.2.1 Private sector . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
3.2.2 Public Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
3.3 Equilibrium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
3.4 Financial shocks and macroeconomic policies . . . . . . . . . . . . . 74
3.4.1 The case of flexible exchange rates and neutral fiscal policy . 75
A flexible exchange rate regime . . . . . . . . . . . . . . . . . 75
The neutral fiscal policy case (FRB, aG = 0) . . . . . . . . . . 78
3.4.2 Other exchange rate and fiscal regimes . . . . . . . . . . . . 80
Calibration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
Different fiscal rules (aG 6= 0) . . . . . . . . . . . . . . . . . . 82
Different exchange rate regimes . . . . . . . . . . . . . . . . 86
The dynamic effects of a financial shock under different regimes 89
3.5 Welfare analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
3.5.1 Optimality of flexible exchange rates in the neutral fiscal policy case 90
3.5.2 Optimal fiscal and exchange rate policies . . . . . . . . . . . 91
Optimality under the baseline specification . . . . . . . . . . 91
Optimality under other specifications . . . . . . . . . . . . . 94
3.5.3 Optimality of countercyclical fiscal policy . . . . . . . . . . . 97
3.6 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98
3.7 Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99
3.7.1 Determinacy of equilibrium. The case of two predetermined variables and one non predetermined  99
3.7.2 Corporate risk premium and Steady State . . . . . . . . . . . 101
3.7.3 Steady State. determinacy of equilibrium . . . . . . . . . . . 103
3.7.4 Effects of a financial shock on real depreciation and investment105
3.7.5 The dynamics after the shock under flexible exchange rates 106
3.7.6 The dynamics after the shock under fixed exchange rates . 108
3.7.7 Effects of a financial shock on taxes and labor . . . . . . . . 110
3.7.8 A second order approximation to the utility function . . . . 111
3.7.9 Endogenous sovereign risk . . . . . . . . . . . . . . . . . . . 112
3.7.10 Optimal policy combinations with endogenous sovereign risk mG = 0.02 and vulnerability  113
Bibliography 115