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Misalignment, liabilities dollarization and exchange rate adjustment in Latin America

Author

Listed:
  • Enrique Alberola

    (Banco de España)

Abstract
Exchange rates in Latin America display a large volatility, constitute a central element of the policy strategies and their evolution have an important impact on financial stability due to the dollarization of liabilities which most countries exhibit. However, assessments on equilibrium exchange rates are scarce in the region. This paper aims at both filling this gap and analysing the impact of the adjustment of the exchange rates to equilibrium on financial stability. Building on the methodology of Alberola et al (1999-2002), we show that the stock of net foreign assets and the evolution of productivity are the fundamentals underlying the behavior of the real exchange rate. Using an unobserved components methodology in a cointegration framework, a time varying equilibrium real exchange rate is derived, and deviations from this equilibrium provide an estimate of the degree of multilateral misalignment. The results uncover among other things the large overvaluation of the Argentinean peso in 2001, which was only partially explained by the estimated dollar overvaluation. The adjustment of exchange rates in 2002 corrected this and, to a lesser extent, other misalignments. The final part of the paper addresses the impact of liability dollarization on the adjustment of exchange rates. It is argued that the real exchange rate will tend to overshoot its equilibrium level, due to the need to foster higher current account surplus in the aftermath of depreciation to make up for to the increase in liabilities. An adjustment to account for this effect is performed on the previous results. This overshooting, when coupled with sudden stops of capitals, may help explaining the higher volatility of real exchange rates in the region.

Suggested Citation

  • Enrique Alberola, 2003. "Misalignment, liabilities dollarization and exchange rate adjustment in Latin America," Working Papers 0309, Banco de España.
    • Handle: RePEc:bde:wpaper:0309
    as

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    References listed on IDEAS

    as
    1. Canzoneri, Matthew B. & Cumby, Robert E. & Diba, Behzad, 1999. "Relative labor productivity and the real exchange rate in the long run: evidence for a panel of OECD countries," Journal of International Economics, Elsevier, vol. 47(2), pages 245-266, April.
    2. Hamid Faruqee, 1995. "Long-Run Determinants of the Real Exchange Rate: A Stock-Flow Perspective," IMF Staff Papers, Palgrave Macmillan, vol. 42(1), pages 80-107, March.
    3. Alberola, Enrique & Lopez, Humberto & Serven, Luis, 2004. "Tango with the Gringo: the hard peg and real misalignment in Argentina," Policy Research Working Paper Series 3322, The World Bank.
    4. Olivier Jeanne & Charles Wyplosz, 2003. "The International Lender of Last Resort. How Large Is Large Enough?," NBER Chapters, in: Managing Currency Crises in Emerging Markets, pages 89-124, National Bureau of Economic Research, Inc.
    5. Alejandro Izquierdo & Ernesto Talvi & Guillermo A. Calvo, 2002. "Sudden Stops, the Real Exchange Rate and Fiscal Sustainability: Argentina's Lessons," Research Department Publications 4299, Inter-American Development Bank, Research Department.
    6. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange rates and financial fragility," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 329-368.
    7. Tamim Bayoumi & Ronald MacDonald, 1999. "Deviations of Exchange Rates from Purchasing Power Parity: A Story Featuring Two Monetary Unions," IMF Staff Papers, Palgrave Macmillan, vol. 46(1), pages 1-5.
    8. Ms. Susana Garcia Cervero & J. Humberto Lopez & Mr. Enrique Alberola Ila & Mr. Angel J. Ubide, 1999. "Global Equilibrium Exchange Rates: Euro, Dollar, “Ins,” “Outs,” and Other Major Currencies in a Panel Cointegration Framework," IMF Working Papers 1999/175, International Monetary Fund.
    9. Alejandro Izquierdo & Ernesto Talvi & Guillermo A. Calvo, 2002. "Sudden Stops, the Real Exchange Rate and Fiscal Sustainability: Argentina's Lessons," Research Department Publications 4299, Inter-American Development Bank, Research Department.
    10. Enrique Alberola & Susana Garcia-Cervero & Humberto López & Angel Ubide, 2005. "Quo vadis Euro?," International Finance 0507004, University Library of Munich, Germany.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Equilibrium Exchange Rates; Liabilities dollarization; Overshooting;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models

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