History, Politics and Economics
Edited by Joëlle Leclaire, Tae-Hee Jo and Jane Knodell
Chapter 12: Exchange Rate Regimes and the Impact of the Global Crisis on Emerging Economies
Alfredo Castillo Polanco and Ted P. Schmidt INTRODUCTION The global financial crisis was sparked by the collapse of the US housing bubble and was quickly transmitted to the rest of the world through the deterioration of mortgage-backed assets held by global investors. The financial crisis triggered a global recession as the decline in the US economy caused a decline in world trade, which was especially problematic for small, open economies. Prior to this crisis there was a growing literature that looked at the impact of external shocks on developing or emerging market economies in relation to the exchange rate regimes (ERRs) adopted by the monetary authority (Fischer, 2001; Levy-Yeyati and Sturzenegger, 2003; Farrant and Peersman, 2006). Most of the research focused on evaluating which ERR was the best ‘shock absorber’; that is, which ERR minimizes the shock’s impact on domestic growth and inflation. A second issue addressed in many of these studies was how to accurately categorize ERRs, because the regime announced (de jure) by the monetary authority is often not what it does in practice (de facto regime). One of the weaknesses in much of the previous work is the use of macro models that are not representative of developing economies, specifically with respect to substitutability between external and internal markets. The purpose of this chapter is twofold: first, we construct a Post Keynesian model that better characterizes the operative mechanisms in developing economies, specifically related to experiences with low substitutability and balance of payments restrictions; second, based on...
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