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Preventing Currency Crises in Emerging Markets$
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Sebastian Edwards and Jeffrey A. Frankel

Print publication date: 2002

Print ISBN-13: 9780226184944

Published to Chicago Scholarship Online: February 2013

DOI: 10.7208/chicago/9780226185057.001.0001

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Dollarization of Liabilities, Net Worth Effects, and Optimal Monetary Policy

Dollarization of Liabilities, Net Worth Effects, and Optimal Monetary Policy

Chapter:
(p.559) 12 Dollarization of Liabilities, Net Worth Effects, and Optimal Monetary Policy
Source:
Preventing Currency Crises in Emerging Markets
Author(s):
Luis Felipe Céspedes, Roberto Chang, Andrés Velasco
Publisher:
University of Chicago Press
DOI:10.7208/chicago/9780226185057.003.0013

This chapter explores the optimal exchange rate and monetary policies in emerging countries. It specifically evaluates whether domestic monetary authorities should actively defend their currencies against speculative attacks. Highly variable nominal interest rates, or nominal rates that rise when adverse shocks hit, are not an indication of fear of floating. The shock and the associated monetary policy resulted to an increase in wage inflation. Social loss is larger under fixed rates than under the discretionary solution presented. Even if fixed exchange rates enjoy a credibility advantage, they do not yield higher welfare than does optimal floating under discretion. Under the three alternative discretionary flexible exchange rate regimes, it is noted that the welfare losses are lower than under fixed rate regimes. Moreover, balance sheet effects are very severe when the move to floating exchange rates is a result of a currency collapse.

Keywords:   optimal exchange rate, monetary policy, wage inflation, social loss, fixed exchange rates, optimal floating, currency, balance sheet

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